Deflation is not Bitcoin’s Achilles’ heel

A few days ago, I saw such a question on Zhihu:

“If the world uses Bitcoin, will the economy be more stable?”

The top answer is roughly "Bitcoin, which is naturally deflationary, cannot be used as a currency. It will be withdrawn from circulation at the fastest speed, and then people will invent other currencies." The reason is that with a fixed total amount of Bitcoin, the continuous increase in goods means that Bitcoin will continue to appreciate, while prices will continue to fall. The author concludes that we will return to direct exchange and hoard the appreciating Bitcoin.

This is a common view, and it seems to make sense at first glance, but upon closer examination, we will find that this common accusation of deflation is wrong.

First of all, it should be pointed out that the invention of money solves the problem of the double coincidence of needs and greatly facilitates human exchange. People would rather endure the disadvantages of a certain degree of inflation than return to barter. Similarly, a certain degree of deflation will not make humans return to barter.

Then, before we discuss deflation, we must first clarify the definition of deflation. The common definition of deflation is a decline in the overall price level. But this definition covers up too many problems, for example, we cannot tell whether the reason for the decline in prices is a decrease in the amount of money or an increase in the amount of goods produced. A more accurate definition of deflation is a decrease in the money supply; in contrast, inflation is an increase in the money supply. In this way, we can see the problem more clearly. Obviously, productivity has increased and more goods have been produced, so why are prices still rising? The answer is that someone has put your money into his pocket by issuing more currency.

After clarifying this definition, we will find that, at present, Bitcoin is an inflationary currency. The number of Bitcoins will increase every day according to Satoshi Nakamoto's setting until all the coins are mined. After that, counting the occasional loss of some coins, Bitcoin is considered a deflationary currency.

In theory, with a relatively stable money supply, we should not be afraid of falling prices due to increased productivity - who doesn't like to buy more things with their money? But some economists tell us that deflation will increase actual debt, stifle aggregate demand, and shrinking consumption will lead to lower sales and profits of companies, and ultimately increase unemployment. As a result, people gradually formed the view that deflation is harmful - even more harmful than inflation - and turned to support "mild inflation." But is this statement reliable?

Let's look at the former first, the argument that deflation increases real debt. In deflation, people must sell more goods and services to repay their debts, so creditors benefit and debtors lose. We do not intend to deny this, but we must point out that in a complex world, many people are often both creditors and debtors, and we cannot be sure who is the net beneficiary and who is the net loser. In addition, if the rate of deflation is anticipated in advance - which is the case in the world of Bitcoin - then the nominal interest rate will change accordingly. The losses of debtors will also be reduced accordingly. Finally, it also reduces the impulse to borrow money, forcing us to be more cautious.

Consider the idea that deflation kills demand and consumption. Some people believe that deflation—and the resulting fall in prices—will cause people to spend less because they will wait until the next day for a cheaper price, which means less demand. But that is not true. Take smartphones, for example. Even though we all know that the price of a smartphone will drop after it goes on sale, we will still buy it if we want it. Very few people will wait until the price is the lowest before it is retired. If people put off spending because of falling prices, they will go hungry, cold, and naked. In fact, people will always consume a certain amount of goods in the present, regardless of how they expect prices to change.

To sum up, deflation itself is not something we should worry about. For more details, please refer to Philip Baggs's upcoming new book "The Deflation Question".