Difference between revisions of "Deflationary spiral"

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'''Deflationary spiral''' is an economic argument that proposes that a runaway deflation would eventually lead to the collapse of the currency. It is a common criticism made against the viability of [[Bitcoin]].
 
'''Deflationary spiral''' is an economic argument that proposes that a runaway deflation would eventually lead to the collapse of the currency. It is a common criticism made against the viability of [[Bitcoin]].
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The ‘deflationary spiral’ is a real condition that affects the fiat fractional reserve backing system.  Understanding why Bitcoin isn't affected by this problem you must first understand why it is a problem for our current system.<br />
  
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Deflationary spiral occurs when the price of a commodity increases at some given rate which causes people to hoard it. As people hoard the commodity, less and less of it is available thus causing the price to go up even more. In turn, even more people hoard the commodity. Thus a feedback loop or spiral of deflation occurs.
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Deflationary spiral occurs when the price of a traded article increases at some given rate which causes people to hoard it. As people hoard the commodity, less and less of it is available thus causing the price to go up even more. In turn, even more people hoard the commodity. Thus a feedback loop or spiral of deflation occurs.<br />
  
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==Effects==
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In practice, there is only a limited amount of 'value' that can be placed upon a good before it becomes too attractive to trade for other goods (thus ending the spiral).  The only time that the 'Deflationary Spiral' can happen (to it's conclusion) is when people can foresee a time where they are forced to use that particular traded article.
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Deflation, like inflation, includes winners and losers.
 
  
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The losers are borrowers, especially those who would have to pay principle plus interest rate. Since the value of loan increase due to inflation, that means they will have to pay more in real term.
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==In The Fiat Fractional Reserve Banking System==
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The fiat money that we trade consists of the principle of the loans of other people. All this money must be someday 'repaid.'  When people save (pay back their loans), the total monetary supply is contracting.  When people spend (take out loans), the total monetary supply is increasing.
  
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The winners include anybody who had saved. Thus, a deflationary environment would automatically encourage more people to save for the expectation of increasing purchasing power.
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If you have people who are hoarding money, the principle still need to be repaid. Hoarding will make it harder for other people in the economy to pay back their loans.
  
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==Economic history==
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Becasue people foresee a time where they need to pay back their loans (a future fixed expense, when the value of the money starts to increase (deflation), those with loans will endeavour to pay back the loans quicker.  This causes the monetary supply to reduce, reducing the total amount of money available for repayment of loans, again making it harder for people to pay back what they owe.
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The first deflationary phase in Bitcoin's economic history is a phase of economic growth caused by the slashdot effect. From there, we see the the price of bitcoin rose to 0.06 USD. This price level remain stable until early October, when a rally cause the price to touch .50 USD before settling at the .20-30 USD equilibrium.
 
  
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There will only be 21 million bitcoin in the world, ever. Thus, the expected value of bitcoin rise in correlation with the number of people using it, as well increase in productivity. Further deflation occurs with people losing their wallet, thus all access to their bitcoin. While the destruction of bitcoin never occurs, the loss of key to access it effectively mean that bitcoin can never be used again.
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This Deflationary spiral diverts funds away from the legitimate economy, to the repayment of debt. Causing the economy to stagnates and stop.
  
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Over the long term, as long as the combination of the two causes hold true, deflation will continue to an absurd level.
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==Bitcoin==
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The key difference is that people don't foresee a fixed cost (unit amount) that they must pay with Bitcoin.  If the value of the Bitcoins that they own increases, then any future cost will take a proprietary smaller amount of Bitcoin.  There isn't any fixed incentive to holding Bitcoin other than speculation.
  
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==Counterargument==
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If the economy that uses Bitcoin grows, the per-unit value of Bitcoin proportionally increase also.
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There is lots of confusion about this topic from modern-day economists.<br />
 
  
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The ‘deflationary spiral’ is a real condition that affects the fiat fractional reserve back system.  Understanding why Bitcoin isn't affected by this problem you must first understand why it is a problem for our current system.<br />
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Everything is the opposite to the fiat fractional reserve banking system (because Bitcoin isn't a debt but an assist).  Bitcoins '''only''' deflate in value when the Bitcoin Economy is '''growing'''.
  
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In our current monetary system there is no ‘money’ as an asset but a whole lot of ‘principle to loans.'  When the money supply is contracting (deflation) people are paying back their loans. (or saving). The other thing is to understand is there is more loans (principle to be repaid) issued than ‘money,’ so when loans are paid back, the available money supply to pay back all the other outstanding loans gets smaller.<br />
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Becasue the Deflationary spiral is a real problem in the traditional monetary system, doesn't necessitate that it can also be a problem in the Bitcoin economy.
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When the economy is booming or growing, more and more people take out loans to fund their future endeavours, thus increasing the monetary supply.  Because the economy is growing, this masks the real inflation (of the monetary supply). The deflationary spiral happens when people start saving because of a slowing or contracting economy.  The money supply gets smaller (as the loans get paid off), finding money for repaying the remaining loads becomes disproportionally harder to find.<br />
 
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People who hoard (are debt free) are making it harder for those who have loans to repay them.  The loans get harder and harder to repay (the value of money goes up), and people start defaulting.  Thus in the current economic system, dollars will become very expensive stopping people spending, slowing the economy. Not because they are saving (for future spending), but because they are paying back their loans (so they don't have to pay interest).<br />
 
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Bitcoins are different.  Bitcoins go up in value when the bitcoin economy grows, and go down in value when it contracts.  Everything is the opposite to the fiat fractional reserve banking system (because bitcoin isn't a debt but an assist).  Bitcoins '''only''' deflate in value when the Bitcoin Economy is '''growing'''.  Becasue the Deflationary spiral is a problem in the traditional monetary system, doesn't necessitate that it can also a problem in the Bitcoin economy.
 
  
 
==See Also==
 
==See Also==

Revision as of 05:13, 24 April 2011

Deflationary spiral is an economic argument that proposes that a runaway deflation would eventually lead to the collapse of the currency. It is a common criticism made against the viability of Bitcoin. The ‘deflationary spiral’ is a real condition that affects the fiat fractional reserve backing system. Understanding why Bitcoin isn't affected by this problem you must first understand why it is a problem for our current system.

Deflationary spiral occurs when the price of a traded article increases at some given rate which causes people to hoard it. As people hoard the commodity, less and less of it is available thus causing the price to go up even more. In turn, even more people hoard the commodity. Thus a feedback loop or spiral of deflation occurs.

In practice, there is only a limited amount of 'value' that can be placed upon a good before it becomes too attractive to trade for other goods (thus ending the spiral). The only time that the 'Deflationary Spiral' can happen (to it's conclusion) is when people can foresee a time where they are forced to use that particular traded article.

In The Fiat Fractional Reserve Banking System

The fiat money that we trade consists of the principle of the loans of other people. All this money must be someday 'repaid.' When people save (pay back their loans), the total monetary supply is contracting. When people spend (take out loans), the total monetary supply is increasing.

If you have people who are hoarding money, the principle still need to be repaid. Hoarding will make it harder for other people in the economy to pay back their loans.

Becasue people foresee a time where they need to pay back their loans (a future fixed expense, when the value of the money starts to increase (deflation), those with loans will endeavour to pay back the loans quicker. This causes the monetary supply to reduce, reducing the total amount of money available for repayment of loans, again making it harder for people to pay back what they owe.

This Deflationary spiral diverts funds away from the legitimate economy, to the repayment of debt. Causing the economy to stagnates and stop.

Bitcoin

The key difference is that people don't foresee a fixed cost (unit amount) that they must pay with Bitcoin. If the value of the Bitcoins that they own increases, then any future cost will take a proprietary smaller amount of Bitcoin. There isn't any fixed incentive to holding Bitcoin other than speculation.

If the economy that uses Bitcoin grows, the per-unit value of Bitcoin proportionally increase also.

Everything is the opposite to the fiat fractional reserve banking system (because Bitcoin isn't a debt but an assist). Bitcoins only deflate in value when the Bitcoin Economy is growing.

Becasue the Deflationary spiral is a real problem in the traditional monetary system, doesn't necessitate that it can also be a problem in the Bitcoin economy.

See Also

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