Bitcoins and The Spectre of Deflation

I haven’t really blogged about Bitcoin before, but it’s been impossible to ignore this week as the decentralized, anonymous crypto-currency soared to record values and every pundit piped up to predict its fate. If you’ve never heard of Bitcoin, or want to fill in the gaps, check out these explanations and analyses by Felix Salmon (generally pessimistic) and Priceonomics (guardedly optimistic).

Libertarians and anarchists and the like hate centralized currencies like our Federal-Reserve-controlled dollar system because of how easily money can be “printed” to “debase” the currency and risk “hyperinflation,” etc, etc. Bitcoin shares the limited quality of gold, but cleverly applies technology to improve on gold’s drawbacks, like the difficulty of dividing into smaller units for exchanging, while preserving cash-like qualities such as anonymity.

It remains to be seen how governments will tolerate Bitcoin and other similar digital currencies, but initial reactions are more hopeful than might be expected by the anarchist types who hope such innovations will accelerate the collapse of the state. Bitcoin’s lead developer Gavin Andresen gave a talk at the CIA; perhaps officials are less concerned about untraceable, illicit transactions and more intrigued about covertly transferring money for secretive foreign operations.

The Deflation Downer

At any rate, many economists seem ultimately unimpressed by Bitcoin, and it has little to do with whether or not it’s currently a bubble. The limited supply that hard money advocates see as a “feature” is really a “bug,” they argue. As Felix explains:

Inflation is bad, but deflation is worse… in a deflationary environment, no one spends money — because whatever you want to buy is sure to become cheaper in a few days or weeks…

The result is an economy which would simply grind to a halt, with massive unemployment and almost no economic activity. In a word, it would be a Depression. In order to have economic growth, you need monetary growth as well… And that’s why bitcoin can never really succeed over the long term.

This makes sense at an Econ 101 level, but I wonder if it’s an oversimplification. (I find it ironic that many economists who apparently accept this simple cause-and-effect deflationary spiral also dismiss simple explanations for, say, minimum wage increasing unemployment.)

Now deflation and money supplies are old, long-studied concepts, and there are probably many nuances and maybe even empirical evidence I need to learn about. But it almost seems to be, as Crimson Reach likes to say, an yes/no issue that should be treated as a how much issue.

Is Deflation Really So Bad?

Here’s a (dangerous) train of thought I’ve been following the last couple days.

The technology industry has been deflating for decades. Computers, music players, flash drives, phones, tablets – they’re constantly increasing in value and decreasing in price, probably at rates often well above 10% annually. Consumers have grown so used to this that they expect every new gadget to get better and cheaper over time.

Yet people have not stopped buying the new gadgets just because the prices will deflate. Electronic gizmos are flying off the shelves because consumers still value the present ones more than their cost.

Now this may not apply to the economy generally, but it must account for something. Economies with low inflation do not necessarily have dangerously low savings rates, so why must economies with low deflation necessarily have dangerously high savings rates?

If the price of toilet paper is gonna decrease 2% every year, I’m still gonna buy it this year. More “durable” goods may not benefit from such inelastic demand, but as we see with the technology sector it does not guarantee disaster. People would save more, but I need to be convinced they would save too much. It’s entirely possible people are not saving enough right now anyway.

There’s probably a wrinkle in deflation’s discouragement of the debt that so much of our economy seems to depend on, and maybe this is where the deflationary spiral kicks in – we’ve seen falling house prices trap borrowers and hurt the economy in ways that falling iPhone prices don’t. (But maybe interest rates would work differently under a deflationary money supply as well?) “Sticky wages” could be a problem. And other things, too.

I have a lot to learn about this stuff. I don’t know what will happen with Bitcoin, and for all my distrust of the Federal Reserve, I’m no goldbug. But it’s fun to see Bitcoin go farther – not so much in dollar value, but in attention, adoption, and acceptance – than many of its stuffy detractors expected, and to wonder how much farther it will go.