Krugman's Baby-Sitting Co-op Explains The Design Flaw At The Heart Of Bitcoin

http://www.forbes.com/sites/pascalemmanuelgobry/2013/04/05/krugman-baby-sitting-co-op-bitcoin/

by rosser • 13 years ago

48 107 13 years ago

Jtsummers4• 13 years ago

Well, I just linked to the cited Krugman article. In case anyone else has difficulty with the pkarchive.org link, here's another source: http://www.slate.com/articles/business/the_dismal_science/19...

drcode12• 13 years ago

The mistake in the article is that bitcoins can subdivide AND increase in value. Bitcoins are not going to have liquidity crisis, as much as some people seem to want it to.

podperson2• 13 years ago

If/when bitcoins ever become an important currency they will have all the same problems as other currencies, and others unique to being bitcoins. E.g. central banks will try to manipulate them, governments will tax and regulate them, and people will speculate on them.

Being able to subdivide and increase in value are not attributes unique to bitcoins.

Oh, and the article DOES address this exact point.

drcode12• 13 years ago

> Being able to subdivide and increase in value are not attributes unique to bitcoins.

I didn't claim that.

> Oh, and the article DOES address this exact point.

No, they always assume the value of a coin remains constant when discussing subdivision.

danmaz74• 13 years ago

There won't be a liquidity crisis only if all people dealing with bitcoins will accept to lower their prices in response to the deflation of the currency - this would include workers paid with bitcoin. Not very likely. Would you accept to be paid less and less every year (month, week...)?

drcode12• 13 years ago

> Would you accept to be paid less and less every year (month, week...)

Because they'd be able to buy more and more with that money, obviously.

thyrsus• 13 years ago

The problem is that they increase in value, to a degree that the individually rational choice is not to spend them "now". The babysitting coop coupons were effectively subdividable as well: participants could have taken the initiative to say "I'll provide two hours of babysitting for an hour coupon" or "I'll provide 15 minutes of babysitting for 1/2 an hour coupon". [Edit, for elaboration] That would be rational when the value of babysitting in the further future (e.g. Valentine's day) exceeds the value of babysitting in the nearer future (e.g, Feb. 11).

drcode12• 13 years ago

If there had been a liquid, open market for coupons and the coupons could subdivide they would have been fine.

mpyne2• 13 years ago

Subdiving does not increase the overall supply of Bitcoin though. There would be no way in the future to obtain Bitcoin, except by taking it from someone else. Or someone else's hoard, as the case may be. (This is at least briefly touched on in the article)

This is also covered in the book "Debt: The First 5000 Years", when gold-standard and silver-standard monarchies had real problems keeping money in circulation due to the effects of merchants' savings and overall finite supply mixed with the large demand for coin in the Orient.

drcode12• 13 years ago

For liquidity, what matters is that the VALUE of the liquidity is adequate. Whether you're trading full bitcoins or fractions of a bitcoin doesn't matter.

dmm4• 13 years ago

To me it seems the problem with the Babysitting coop was price fixing. The price of of an hour of babysitting was always 1. If the price of an hour of babysitting was allowed to float you would not have the shortages.

Jtsummers4• 13 years ago

See the original Krugman article. It goes further into explaining efforts to try and rectify their economy, as well as a general discussion on the principles involved.

crazygringo2• 13 years ago

Well, right. They added more coupons, which fixed the problem.

But I don't see how that's significantly different from allowing the price of babysitting to float -- I know doubling the number of coupons isn't exactly the same as making them half as valuable, but it's similar.

But since bitcoins simply adjust in value according to market demand, I, as well, don't understand how Krugman's story applies to bitcoin. If everyone thinks bitcoin's value will always go up, because it's deflationary, and everybody hoards -- well not everybody will, right? There must be other factors at hand, surely?

wwweston• 13 years ago

Float compared to what? The price of an hour of babysitting was always 1 because the only thing on the exchange is an hour of babysitting.

I suppose you could argue some hours of babysitting are more valuable than others, and people could negotiate, say, 4 hours for 5 coupons or vice versa. It's not clear this either (a) wasn't already done on some ad hoc basis (I'd imagine if it was agreeable to both parties, it'd probably happen) or (b) would have provided a solution to the liquidity problem, though.

unoti2• 13 years ago

Float compared to supply and demand in a free market. Instead of issuing 1-hour coupons, they should have issued an arbitrary currency, say, Shillings. Then buyers can request babysitting paying at 1 shilling per hour, and sellers could say that they want 1.3 shillings per hour. The value of the currency needs to float with supply and demand.

The whole argument in the article is a pathetic straw-man. The value of bitcoin floats with supply and demand. When the supply is fixed when bitcoins can no longer be mined, then the supply is based on how much is circulating vs being held.

ChuckMcM2• 13 years ago

Think about that in somewhat more pragmatic terms. Lets say Alice babysits for Bob for 1 coupon per hour. And hoards coupons. Over time as the supply of coupons becomes more precious she can charge larger and larger 'rates' for her services. Eventually she has all the coupons and nobody else can get any baby sitting.

At which point we discover her maiden name is Bernanke! And she has set herself to be the central bank of babysitting coupons, which she will loan out but only at extortionate rates bwa ha ha ha!

Basically if someone has all the currency then you can't really make a market with it. Even if the prices fluctuate. Long before the market shuts down it becomes very inefficient.

trhtrsh5• 13 years ago

Once Alice has all the coupons, nobody can get any babysitting because they have consumed babysitting without producing anything. Either they need to start babysitting for Alice, or find something else valuable to sell to Alice, or decline to babysit and leave Alice stuck with a pile of worthless coupons.

james10714• 13 years ago

There was only one good, so the price cannot float

dmm4• 13 years ago

Babysitting on April 5th is a different good than babysitting on December 31st.

gluczywo2• 13 years ago

It's a good point. Coupons were a pegged currency (with fixed exchange rate to commodity or to other currency). The same wrong assumption that made Bretton Woods failed.

forgingahead• 13 years ago

In 1998, Krugman also predicted that "by 2005 or so, it will become clear that the Internet's impact on the economy has been no greater than the fax machine's."

http://web.archive.org/web/19980610100009/www.redherring.com...

squid_ca• 13 years ago

That has nothing to do with whether he is right or wrong about this issue, though.

gwern• 13 years ago

http://www.reddit.com/r/Bitcoin/comments/1bl0jd/in_2011_paul...

hatu• 13 years ago

Funny how the title of the article is "Why most economists' predictions are wrong." I think he's really out of his element, making more technological than a economical prediction.

27182818284• 13 years ago

The overwhelming main gripe I read not only on HN, but also on business websites is that Bitcoins aren't US dollars.

It reminds me of the apocryphal, famous Ford quote, "If I had asked my customers what they wanted they would have said a faster horse."

hodgesmr• 13 years ago

Watch out. You posted an article on HN that doesn't praise Bitcoin. And, you know, all software developers are also economists. Expect a backlash.

jl6• 13 years ago

I don't quite buy the analogy. Seems to me that part of the problem was having tokens that could only be exchanged for one thing, and even then at a fixed exchange rate.

dsr_• 13 years ago

Here the problem is that bitcoins are illiquid: you can't spend them freely on most goods and services, and you can't get a consistent exchange rate into a liquid currency, and the supply problem means that hoarding is sensible... right up until the crash.

ph0rque2• 13 years ago

Can someone pro-bitcoin provide a counterpoint to the deflationary spiral criticism? I don't have enough of an understanding in economics to think of one.

1053r• 13 years ago

The flaw in the argument is that BitCoin is not (currently) a unit of account (we don't price contracts or goods or services in BTC), and is (nearly) infinitely divisible.

So even if 90% (or 99%) of all BTC is being hoarded, the other 10% (or 1%) can be divided up for use in transactions. That much speculations will cause wild gyrations in value and massive short term volatility, but the people using BTC to transact JUST DON'T CARE.

I really don't care if I'm buying my $1000 flat screen with 1 BTC or 0.0001 BTC. Neither does the merchant. I bought the BTC, sent it to the merchant, and the merchant sold it so quickly that the value didn't change much, and we are happy.

So that's the short term. In the long run, the volatility might decrease as the total market capitalization increases to 10x or 1000x of its current value.

Then we can start to think about using it as a unit of account. If we do, we may enter a deflationary spiral, but by then BTC will already be used in an enormous swath of the economy.

So I interpret Krugman's argument not so much that BTC CAN'T take over the world, but that it SHOULDN'T take over the world. (I'm not sure if I agree. Many economists have been arguing over this point for decades, and I'm not smart enough to sort it all out.)

danielweber2• 13 years ago

That's using Bitcoin merely as a payment mechanism, where both the buyer and the seller hold onto it for as short a time as possible.

ars7• 13 years ago

That is not a flaw in the argument - that is a flaw in your understanding of the argument, which makes you think this is a valid rebuttal.

Money is supposed to represent value. Not to actually be value. There are new humans arriving in the world all the time. And new resources are being mined from the earth, and created intellectually all the time.

If the money supply does not match these new things then the currency fails.

You can't just do a "currency split" and issue more notes - doing that effectively tells everyone their resources are half as valuable which is clearly wrong - the value of the resources didn't change.

You need to issue more currency so that the sum total of money available is equal to the sum total of value in the world. Any currency that doesn't do that fails.

mncolinlee2• 13 years ago

Unfortunately, deflation is not so simple a concept. If your currency quickly deflates and hoarders EXPECT it to deflate, no one will be interested in lending and the economy will suffer.

Lending is not an optional feature in a modern economy. You need some level of lending to have credit balances with merchants or investment in stocks and bonds. An economy without lending can take few risks on innovation, such as YCombinator has. They also have less incentive to spend money hiring employees because the risk/reward ratio is higher.

A currency that continuously deflates is also likely to hit a liquidity crisis when everyone attempts to sell at once and the exchanges stop buying. We've already seen exchanges stop selling or choose to impose hurdles to buyers because Bitcoin demand was too high.

Until they resolve the money supply issues, the Bitcoin is likely to remain merely an expensive and risky proxy for illicit drugs.

james10714• 13 years ago

Your scenario of an ever increasing currency is impossible, because everyone will hoard it. No transactions will be possible because it will be impossible to buy.

narrator• 13 years ago

Krugman is talking about "The Paradox of Savings". Here's F.A Hayek's rebuttal to the argument when it was originally proposed back in the 30s: (http://mises.org/daily/2804) (Sorry if I'm a bit of a broken record on this but it applies too well to bitcoin).

white_devil3• 13 years ago

> provide a counterpoint to the deflationary spiral criticism?

Is that the retarded idea that no one will buy anything if prices keep falling? Look no further than computers, cell phones and all manner of electronic gadgets. Their prices keep going down, but everyone keeps buying them.

If you need/want something now, you'll buy it now.

Here's a summary of the article: "The State-Controlled Mainstream Media paints a gloomy picture of a currency that can't be controlled by the State."

EDIT: Perhaps a downvoter might want to point out a flaw in what I said?

ars7• 13 years ago

Why do you think they constantly make more gadgets - always at the same price point? And they work really hard to make sure you want the new one.

In some future world where no one wants the new gadget the price of the old one will stop falling!

Jtsummers4• 13 years ago

Not a downvoter (can't, probably won't when I can), but your tone is unnecessarily aggressive and dismissive, especially considering GP just wanted a rebuttal and made no claims of their own.

james10714• 13 years ago

Yes, people will obviously buy the things they need immediately but will defer purchases where they can. Houses would be an obvious example. Everyone would try to spend less, reducing total output.

bdr• 13 years ago

Just because an asset perpetually appreciates does not mean it has a present value of infinity. I hope to write a deeper rebuttal soon in the form of a blog post.

johnny40002• 13 years ago

Seems to me it's an argument for the status quo, so if you are say Warren Buffet it is a vary valid concern. If on the other hand you just graduated undergrad and had a huge debt and your wage was actually set in bitcoins this would be great for you because the cost of paying off your dept would be from your bitcoin point of view spiraling to zero, as would the cost of everything else. That sounds like a pretty awesome situation to be in.

Be wary of financial explanations, because in most cases when a business person or economist says its good, they either mean its good for keeping things stable, its good for the elite, or its good for the average person, all of which might not be you. For example, you might see someone on CNBC saying they need to make sure they don't have a disorderly default, but really if you are in a position to take advantage of that temporary disorderly market you could gain from that.

maxerickson2• 13 years ago

If you are going to insist on a deflationary economy, you have to admit the possibility of wages going down over time.

For a cartoon example, with high enough deflation and a less than perfect job market, that debt might represent more years of work when you are 35 than it did when you were 25.

ph0rque2• 13 years ago

Thanks for all the replies made in the sibling comments and their descendants.

To me it seems that for the time being (e.g. the next 50? 100? years), as long as we have a currency alternative to bitcoin such as USD, these problems can be avoided by just switching currencies to be able to buy/sell/borrow/invest in, as long as other parties agree to it.

Or am I missing something?

gluczywo2• 13 years ago

Note the contradiction: It was diagnosed that the recession of recent years was caused by uncontrolled lending which was possible thanks to issuing money by central banks and keeping low interest rates in this way. At the same time bitcoin that is free of this flaw and prevents reckless lending is criticized.

Deflation and hoarding was never a real problem. Baby-Sitting Co-op IS a silly story that does not scale. Gold had similar deflationary property as bitcoin and somehow it was used in trade for ages. Critics miss the point that monetary wealth is useless if you can't spend it, so at some point hoarders will say: enough, it's time to use some life. At the end of the day, money is just numbers with the potential to convert it to comfortable life.

My selfish, self-interested side says: I would wish more hoarders who collect numbers and don't convert it, so they don't use real world resources. They leave more for me!

Zigurd• 13 years ago

Bitcoin can't be debased.

a. That's a bug

b. That's a feature

They certainly were designed to be that way, and that was intended to be in sharp contrast with the conventional way currency is managed.

A more sophisticated argument about bitcoin might go this way:

a. Bitcoin provides an alternative that is both a useful experiment and is edifying in a way that may help keep the managers of currency systems honest.

b. Bitcoin is like releasing an uncontrolled nanotech experiment into the environment that could turn all our money into grey goo, and governments better put in place measures to prevent and eradicate experiments like this.

liber8• 13 years ago

This example always amuses me because Krugman guilelessly puts forth the case for central control while glossing over the results:

>>"But eventually the economists prevailed. More coupons were issued, couples became more willing to go out, opportunities to baby-sit multiplied, and everyone was happy. Eventually, of course, the co-op issued too much scrip, leading to different problems ..."<<

Of course, these different problems are just ignored. Krugman never seems to want to discuss whether these new problems, entirely caused by centralized control, are worse than the problem the "alert management" intended to solve in the first place.

It's what makes his oft-use example so excellent. Here you had, presumably, a small group of highly-educated and, presumably, reasonably intelligent folks who couldn't even manage an economy with 150 homogenous players. And yet, we expect much better results when we introduce billions of players and millions of additional variables.

andylei• 13 years ago

i think its ironic that you're putting forth the case for unmanaged economies while glossing over the results.

i think most economists (including Krugman) would agree that managing an economy is hard, and that oftentimes, the people in charge don't get it right. but that doesn't mean the alternative is better.

in this specific case (bitcoin), the alternative to managing the money supply centrally is a fixed supply of money. in an environment where the economy (the gross output of the market) is growing, that leads to deflation. krugman points out that deflation slows down economic activity, possibly catastrophically. do you disagree?

CleanedStar• 13 years ago

The economy is already centrally controlled. A few centuries ago, much of the world, even the outer reaches of Europe, had mostly independent, semi-nomadic people living on it - including the land the USA is on.

Now the vast majority of people are wage slaves for a very tight group of intermarrying heirs - the Waltons, the Koches, the Sauds, the Mars's, the Johnsons, the Newhouses, the Rockefellers etc.

From 1993 to 2008, the US unemployment rate never hit what the current rate is - 7.6% unemployment. Most of those people currently have no control of the economy, or their own lives. The idea that the government's protection of this central racket may lessen is of little concern to most of these unemployed.

seanalltogether2• 13 years ago

In other words, when people run out of physical goods to trade, they will start trading IOUs, at which point inflation has occurred within your economy whether you intended it to or not.

trhtrsh5• 13 years ago

Is it "inflation" if each new IOU is accompanied by a corresponding unit of production?

I thought not, but I am no expert.

seanalltogether2• 13 years ago

Yes, because an IOU can be traded after its initial creation, and due to peoples inherent desire to save (hoard) assets theres no guarantee the IOU will ever be cashed in. Inflation occurs because people learn that more IOUs can be issued then are ever cashed in.

Economies are naturally structured around this asynchronous trading structure because we want to help each other survive.

jrs235• 13 years ago

"If you have a $10 bill and I replace it with ten $1 bills, do you feel richer?"

Yes, If I split my 10 into 10 ones and if 9 can pay today for something that cost 10 yesterday, I feel richer.

This causes folks to save and horde like in Japan. Because its deflationary.

It's more difficult to control the masses via monetary policy if things are deflationary... That's why governments try to maintain slight inflation. Comfortable folks don't produce for the government.

trhtrsh5• 13 years ago

It has nothing to do with "comfortable folks producing for the government" and everything to do with coordinating production and consumption. If everyone produces for 20 years and accumulates money, and there is no inflation for 20 years, and then they all try to retire and spend it, but there is no one to produce, since everyone wants to retire, you get hyperinflation chasing the small amount of available goods. Alternatively you inflate the currency for 20 years, to encourage people to consume their savings as a sustainable pace.

Remember: if you spend your inflationary money NOW on durable goods (canned food, wood, whatever), then you can trade those goods for inflated currency later, and not lose any value.

But, if you don't spend your money (maybe because there is nothing on the market worth buying), then inflation is the natural correction to bring the money supply into balance with the goods supply.

snowwrestler2• 13 years ago

The key point is that bitcoin is not actually a currency (like the dollar or euro), it is a commodity (like gold or silver). Thus it will be subject to speculative bubbles and unpredictable swings in value, and the typical holder will not be able to do much about that.

Central banks and fiat currency remove the danger of speculative bubbles...or at least, they centralize the danger to a single, publicly controlled entity.

drcode12• 13 years ago

> they centralize the danger to a single, publicly controlled entity.

Come to think of it, we should centralize the backbone for the internet in the white house basement, so that we "centralize the danger to a single, publicly controlled entity."

snowwrestler2• 13 years ago

The core address data of the Internet is in fact centralized on behalf of the U.S. government by ICANN.

pjzedalis3• 13 years ago

Coupons are not currency. They were trading coupons of 1 hour babysitting to save from spending real currency on hours of babysitting.

ars7• 13 years ago

Of course a coupon is a currency. What do you thing a currency is? It's a store of value.

trhtrsh5• 13 years ago

currency is a medium of exchange, a token representing a store of value (durable good) elsewhere.

Gold coins are a store of value, since the coin itself can be melted down and used as a good (but these days gold has a pile of speculative bubble on top of it)

pjzedalis3• 13 years ago

Just because something has value does not make it a currency. If that coupon ONLY gets you a reduction in price off something then its a discount. Here is another tidbit that makes it not a currency: coupons are intended to not be redeemed more than once.

If only one person can ever use it then it fails at its intention of goods exchange. It's not currency.

tlrobinson• 13 years ago

"Now, it’s worth noting that this fatal flaw of Bitcoin is not a fatal flaw for all cryptocurrencies or algorithmic currencies. One can imagine a Bitcoin-like currency with a smart algorithmic central bank (indeed, Bitcoin does have an algorithmic central bank–just an economically illiterate one)."

It's also worth noting that it's theoretically possible for Bitcoin's "monetary philosophy" to change over time.

If a majority of Bitcoin miners, and thus (in theory) the "economic majority" (https://en.bitcoin.it/wiki/Economic_majority), agree on changes to the system (for example, the rate of mining) everyone can migrate to newer versions of the software that will accept those rules, and those who don't will risk their version of the blockchain not being accepted by the majority of users.

One interesting question is what happens if there's a fairly even split between the group that accepts the old and new rules. Would the value of each blockchain be effectively halved?

wmf3• 13 years ago

Realistically, Bitcoiners can't even agree to fix unspendable UTXOs. I can't imagine that they would ever agree to devalue their own holdings.

bcoates• 13 years ago

What is there to fix? Can't a minority client just blackball UTXOs, allowing them to exist in the blockchain but refusing to publish or accept transactions built off them?

By definition, a UTXO is not in the history of good money.

_lex• 13 years ago

His argument seems to say that the LIQUID supply of bitcoins is shrinking because people are hoarding them. You can make the same argument for stocks or anything else that is traded for cash, but it's wrong. Everybody will have a price that they're willing to sell at - it's the fundamental idea underlying every exchange market.

kirian• 13 years ago

A slightly related article I read recently about how should we evaluate the claims of people much smarter than ourselves. i.e. in this specific article the example is if Krugman makes some claim about economics should we just accept them as he is probably leagues ahead in terms of knowledge and expierience in the subject.

http://theumlaut.com/2013/03/13/paul-krugman-is-brilliant-bu...

unabridged• 13 years ago

Why is Krugman being thought of as a genius in predicting market trends and pricing assets? He has never proven himself in this way, he does not manage money, he is only rich from book sales. Krugman is just a politician who promotes his own opinion of how the US economy should be handled.

mrb• 13 years ago

Another article that gets it wrong. sigh

"I’ve also been told that this is only valid if the entire world is on Bitcoin"

So far the author is right. The whole world does not run on Bitcoin only, therefore the arguments against Bitcoin do not apply. But here is where he gets it wrong:

"but if you think about the world today, that’s not true. There are plenty of currencies out there, and the supply of some of them is too low, and that hurts the people who use that currency. The fact that the dollar exists doesn’t prevent the yen from being too strong."

The author does not cite examples of people hurt by a currency when a supply is low, because he is wrong: there are no such examples.

I don't know why he cites the Yen. The Japanese economy is not that bad. It is not that great either. But it is doing okay. Therefore if Japan is okay with a deflationary currency, why would not Bitcoin be okay too?

Or someone may cite the example of the failure of the gold standard in the US in the 1960s, but it would be incorrect. The gold standard failed because the US Federal Reserve continued to increase notes in circulation, while not replenishing gold reserves, which triggered all sorts of bad consequences, see [1]. By contrast, in Bitcoin it is algorithmically impossible to increase "notes" (coins) in circulation beyond the limit of 21M coins.

[1] See http://mises.org/daily/3325

pjzedalis3• 13 years ago

One thing that strikes me is the person with the most coupons happens to be the person with the least amount of need for the coupons. Therefore they will never redeem them and eventually everyone runs out.

A true currency (and Bitcoin if its a true currency) allows the most avid babysitter to get other things with it instead of what she already has a surplus of.

Krugman's Baby-Sitting Co-op Explains The Design Flaw At The Heart Of Bitcoin

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