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“the beliefs of many economists”

In an otherwise good article about Bitcoin -- http://www.irishtimes.com/newspaper/finance/2011/1007/1224305381674.html -- +Danny O'Brien wrote: “Its built-in deflationary characteristics may, in the belief of many economists, rule it out as a currency for its foreseeable life.”

Here is an excerpt from a letter that I wrote to him last night (Danny is someone that I know and like personally):

Citation needed! I'm aware of exactly two economists who have commented on Bitcoin's money supply: Paul Krugman, who said that the dearth of trade in goods for Bitcoin was evidence of the problems with a deflationary currency [1], and Russ Roberts, who said that predictable deflation may not be harmful the way the unpredictable deflations of the past have been [2].

"That is considered very destructive in today's economies, mostly because when it occurs, it is unexpected," said Roberts, "In a Bitcoin world, everyone would anticipate that, and they know what they got paid would buy more then than it would now."

There is also one economist who has commented on Bitcoin without directly addressing the money supply issue: Larry H. White [4], who mentioned Bitcoin in a positive light while speaking before a House of Representatives subcommittee (video [5], transcript [6]).

Then there is one person who is "almost an economist" who has commented on the issue of Bitcoin's money supply. Jerry Brito is a
bona fide researcher who sometimes blogs about economics and who works at an economics think tank, but his degree, university department, and all of his scholarly publications are in law rather than economics. His comment on Bitcoin's money supply was that it is immune to the threat of excess inflation [3].

Tyler Cowen is a bona fide economist, but his comment on Bitcoin [7] was so confused (and self-confessedly so!) that I can't tell whether he was saying anything about its money supply or not. I suspect he didn't understand it well enough, when he wrote that comment, to even know what its money supply properties were.

In sum: there is a widespread belief among people (liberals, specifically) that I follow on twitter. This belief is that there is a consensus among real economists that Bitcoin is inherently a terrible idea because it is deflationary, which is a critical flaw. I haven't found evidence for this belief. As far as I can tell there are only two or three economists who even have an inkling of what Bitcoin is, and among those two or three, the majority appear to think that its money supply is not obviously catastrophically wrong.

I suspect the belief stems from thinking that (a) economists agree that a fixed money supply, e.g. the gold standard, is fatally flawed due to the dangers of a deflationary spiral, and (b) that therefore economists would conclude that Bitcoin is fatally flawed. Aside from the question of whether there is truly a modern consensus among economists about (a), it is another step to go from (a) to (b)!

Krugman appears happy to take that step; Roberts is more careful. (This is a good example of what I really respect about Roberts's thinking.)

Krugman's comment is facile. Out of all possible explanations of what causes Bitcoin to have a low level of trade-for-goods, he chooses the explanation that fits his pre-existing interests: gold-standard-like fixed money supply! This is very unlikely to actually be a significant cause of the low level of trade for Bitcoin. New currencies almost always fail. If the failure (so far) of the fixed-money-supply Bitcoin is evidence of the dangers of a fixed money supply, then the failures of the variable-money-supply Beenz and Flooz are evidence of the dangers of a variable money supply, and the successes of e-gold and WebMoney are evidence of the safety of a fixed money supply. More likely the dynamicism of the money supply had nothing to do with the success or failure of any of those.

(Edit: don't miss +Tyler Close's point in the comments below that Bitcoin is currently actually highly inflationary, not deflationary.)

Danny wrote back to me and admitted that he was not aware of any economists other than Krugman who held that opinion about Bitcoin.

[1] http://krugman.blogs.nytimes.com/2011/09/07/golden-cyberfetters/
[2] http://www.technologyreview.com/computing/37619/page2/
[3] http://techland.time.com/2011/04/16/online-cash-bitcoin-could-challenge-governments/2/
[4] http://mason.gmu.edu/~lwhite11/
[5] http://www.freebanking.org/2011/09/13/the-free-competition-in-currency-act-of-2011/
[6] http://financialservices.house.gov/Calendar/EventSingle.aspx?EventID=258253
[7] http://marginalrevolution.com/marginalrevolution/2011/04/the-economics-of-bitcoin.html
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17 comments
 
The impression I get from some people who have bought Bitcoin is that there definitely is a sense in which its an investment in its own right - ie, the currency itself is gaining value, and therefore its worth retaining Bitcoins qua Bitcoins rather than spending them on goods and services.
Is this impression wrong?
 
+Jeremy Fitzhardinge You are correct, people will collect it, and this is exactly how money is born. Let us look at the way modern "paper money" was born, shall we?

People began to gather gold because it was (1) rare, (2) pretty end (3) everlasting (and easy to work with), but only for decorations. Gold still is essentially useless, but still has the intrinsic value due to (1,2,3). Only because of the fact that it was desirable, it could later become money.

In the beginning modern day "paper money" (fiat) had a real connection to gold, but due to US excessive spending, this link had to be broken (1971), and we are now left with "paper money" (money without intrinsic value). Some people (like Krugman) wants us to believe that "paper money" is something good, and the step towards it was intentional (which is incorrect). Since paper money does not have any intrinsic value (that prevents banks from creating more out of thin air), normal deflation cycles can be postponed to a later date. This "quality" is essentially responsible for the economic harmageddon we will experience in just a few years from now, and the inflationary "quality" of paper money will not be able to stop it. Now we have to choose: a) BIG deflation or b) hyperinflation (=paper money is destroyed).

So, if you want to look just one step ahead of the economic "experts" of today, ⓑ may have what is needed to become money. Now it has (1) and maybe even (3). Is it enough though, that is the question?
 
Re Krugman's post, it is interesting to note that the period of Bitcoin history that he was commenting on was massively inflationary not deflationary, as Bitcoin was being minted at a rapid and predictable pace. All participants in that period knew that for the short to medium term Bitcoin had a built-in inflation rate of greater than 40%. So I suspect Krugman's post wasn't based on a full understanding of the data-set.
 
+Tyler Close: that is a very good point. It is likely that Krugman thought that Bitcoin's money supply was already static. His argument could still be valid if we assume that the users of Bitcoin are not looking at the current rate of inflation/deflation, but instead planning ahead for that future day when the level of economic activity denominated in Bitcoin finally outstrips the production of new ⓑ.
 
Technical note: it isn't that Bitcoin had a 40% rate of inflation, it is that it had a 40% rate of increase of the money supply, right? Inflation is the ratio between money supply and real economic activity (approximately, probably, arguably).
 
IANAE, but yes, there was a ~40% rate of increase in the money supply, which arguably caused the massive drop in bitcoin price from 30 to 4 dollars over about 3 months which is about 3000% inflation. Krugman mentioned the massive sell-off, but didn't mention the change in money supply and ignored both for the purposes of his argument.
 
+Zooko O'Whielacronx The former definition of inflation is "increase of money supply". Today increased money supply is measured by M0, M1, M2 and M3. When Krugman talks about inflation he refers to the currencies exchange rate towards other commodities (i.e. a basket of standard commodities), In Krugmans world it does not matter if ⓑ always is inflationary by the old definition (it is), he will only look at the exchange rate.
 
+Zooko O'Whielacronx So, why does Krugman tell us that ⓑ is inherently deflationary? Because the money supply increase of ⓑ will (after a few years) be less than that of most fiat money, i.e. 2% yearly increase (specified by the reserve banks).
 
Haha! Yeah, if it's not threatening to be hyper-inflationary (like fiat money), then it's deflationary I guess, right Krugman? I usually assume that when an economist frowns on hard money it's because it can't be manipulated as easily by economists.
 
Here's a new comment by a bona fide economist:

“This scarcity is partly how Bitcoins derive their value,” says Harvard economics professor David Laibson. “Unlike real resources, from printed money to precious metals, there is no as-yet-undiscovered mother lode waiting to be tapped that will destroy or disrupt value.”

from http://www.t3.com/features/bitcoin-a-licence-to-print-money
 
Later in the article he says:

“Fiat currencies, the ones where the notes or coins and their digital versions are underwritten by the government, have one huge advantage over Bitcoins,” says Harvard economics professor David Laibson. “They don’t involve the kind of self policing that a community currency does. The harnessing of peer-to-peer technology may appeal to coders and anti-capitalist hackers, but most people don’t want to be responsible for ensuring the legitimacy of the money in their pocket, virtual or otherwise. They would rather have the authorities shoulder that burden.”

“At least with sterling or the dollar you can turn around and blame the bankers, rogue traders or governments if things start going badly,” continues Laibson. “If Bitcoins start to bomb then users only have themselves to blame.”

I don't really understand what he means by that. He is into psychology, so perhaps this is the product of that arcane art. :-)
 
Is it anti-capitalist to long for an inflation free currency? So everybody before 1971 were anti-capitalists, since they effectively used gold as global currency? Inflation is more "socialist" in my book, since it taxes everyone with money and reduces the burden of loans.
 
Inflation is also used to manipulate the labor market, making it even more socialist.
 
There was a question about this on Quora (http://www.quora.com/What-do-economists-think-of-Bitcoin), and I answered, linking to this G+ entry. The Quora people hid my answer, saying something to the effect that I should write detail and not just post a link to something external. I don't particularly feel like transcribing what I wrote into a different format just so that Quora can maintain some kind of aura that "this stuff is all special and is all ours". So, people who read that question on Quora will apparently remain unaware of my answer to it here.
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