Sunday, April 14, 2013

The Incredible Shrinking Money

Deflation is toxic for any economy, but particularly for an alternative one like Bitcoin. No matter what kind of currency we're talking about, deflation causes hoarding -- why buy something today if you can buy it for less tomorrow? -- that crushes economic activity. The question is what to do about it. In his classic essay on the Capitol Hill babysitting co-op, Paul Krugman explained that the easiest solution is to just increase the supply of money to meet the increased demand for money. In other words, get that printing press going! That stops hoarding, which gets people buying again, which sets off a new virtuous cycle.
Bitcoin Is No Longer a Currency
Okay. I have to admit that I don't understand the love affair with inflationary currencies and the erosion of savings that results. Part of it is not understanding the distinction between "saving" and "hoarding," other than saving=good and hoarding=bad. But regardless of what you call it, the whole reason for it is not just to get the best price on a flat-screen television, it's to be able to save excess resources for a day when you need them and cannot work to create new resources. Or have decided that fifty years of the rat race is enough. Under an inflationary regime, one's savings (or hoardings, if you prefer) will quietly dwindle away, whether you spend them or not, and so forces investment just to break even. Thus a certain level of risk-taking is required just for an hour of work today to be worth an hour of work in the future. And if that risk doesn't pay off, your only options to recoup it are more work or more risk-taking - and we all know where a lot of risk-taking lead us. Given that, I'm not sure I understand how "virtuous" the cycle of inflation is, since central banks have shown a recurring unwillingness to remove the punch bowl before party guests are being shuttled away in ambulances or the back seats of police cars - so if inflation appears to be making things better in the short run, it's a safe bet that it will continue until it bites everyone in the ass.

It seems to me that the love of inflation is based on a love of consumption. But a certain amount of consumption is a given. No matter how much I think the price of food, clothing and shelter will drop tomorrow, I have to stay fed, clothed and out of the elements today, so the consumption being driven is purely discretionary - things that are nice-to-haves, that I can do without - perhaps forever. This is what allows me to put off buying them, hoping to save just a little bit more by waiting and waiting...

One of the things that caused the most recent bubble in the economy was that the United States was maintaining a negative savings rate - people were, on aggregate - not only spending every dime that came in, but they were borrowing on top of that. And look where it got us.

Looking at this, I disagree with the statement that deflation is necessarily toxic - unless your economy has grown to depend on discretionary spending, the sort of thing that can be pushed forward by threatening an individual's wealth - "You can either buy something with it today, or be left holding worthless paper tomorrow," only works when the timing of spending is up to the individual, and not other factors. After all, one can't simply empty their bank account and stockpile food before the prices go up - unless they plan on eating hardy non-perishables for the rest of their lives, and has someplace to put it all.

If we're in a situation where our economy only works by pushing people to spend money that they don't need to spend as quickly as we can, the toxicity is likely in something other than our choice of currency.

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