Author: Conner Brown
Translation: Flash Chan
Source: Encrypted Valley
Inflation is an invisible tax that slowly sucks wealth away from ordinary people and into the hands of resource aggregators. But BTC can resist inflation.
BTC critics claim that although inflation may be frustrating, alternatives are even worse, and deflation will lead to stagnant economic development.
We believe that the above arguments are not logically valid. This article will be divided into three parts to illustrate:
- Explain the basic concepts of deflation;
- Answer critics' concerns about falling prices;
- Explain how the BTC's money supply mechanism guards against the “deflation spiral”.
BTC's money supply is relatively stable
First, we need to define exactly what is "deflation." While price declines are often referred to as deflation, their formal meaning is a reduction in the supply of money or currency substitutes. Deflation is not a decline in the price itself, but a monetary phenomenon that sometimes causes prices to fall.
In this sense, BTC does not have real deflation. The supply of BTC will not decrease, but will continue to increase until the excavation is completed in about 2140. By then, BTC will reach the physical limit.
Below is the BTC's rate of issue, starting with a relatively high inflation rate and then gradually steadily over time, reaching an upper limit of 21 million.
In the long run, the BTC agreement will neither bring inflation nor deflation. Instead, it is set to counter inflation and eventually it will reach a constant monetary base and no longer increase supply.
Some people may think: “Although the base is expected to be the same, lost BTCs will cause deflation because they will no longer appear in the circulation supply.”
This is not a problem. As crypto asset hosting becomes more professional and user friendly, the loss of BTC will decrease. At the beginning of the birth of BTC, its loss rate was the highest, and this number will continue to decline over time. As the expansion of BTC supply is close to zero, the loss of BTC will be reduced accordingly, and eventually reach a relative equilibrium.
Another point of view of critics is:
“Although the supply of BTC may be stable, the population is growing. Therefore, as more and more people chase currency cakes, a fixed money supply will lead to deflationary pressures.”
This statement is questionable. Around the world, with the acceleration of urbanization, residents have achieved higher levels of education, and population growth has shown a downward trend. As the region with the highest population growth continues to industrialize, this downward pressure will continue into the future.
These are the latest UN estimates of population growth. According to forecasts, the population will reach equilibrium by 2100. This is ideal, and the level of the world's population is consistent with the rhythm of the BTC's issuance rate close to zero.
The supply of BTC will continue to grow in a curve. Since the monetary base remains the same, BTC will not have any inherent price increases or downward pressures. It will serve as a pure basis and prices will only fluctuate based on market participants' signals.
Although this is a succinct way of showing that the BTC is not at risk of deflation, it still does not address the core of the critics' debate: concerns about falling prices. So, with an understanding of the constant monetary base of BTC, let's debunk it!
Answering concerns about falling prices
When critics worry that BTC will “deflate”, they are actually saying “BTC will let prices fall!” In general, critics have three main concerns about price concerns under the BTC “deflation” standard:
But before dealing with these specific issues, let's first establish a basic understanding of how prices work.
Price basics: price falls are natural
Imagine a simple commodity in a highly competitive market, such as a toothbrush, and now assume that the toothbrush is easier to produce every year. Maybe the machine capacity is improving, or the supply chain is becoming more efficient, and so on. What happens if our consumer demand remains the same? It should fall.
This is not surprising. Free markets can cause commodity prices to fall as industry productivity increases and competitors compete for consumers at the lowest possible price. This is a process that has taken place for thousands of years, and humans use their ingenuity to meet the needs of others.
Is the price always falling? of course not! Many common events that hinder production or lead to a surge in demand can lead to price increases. My point is simple. For a long time, as humans have become more productive with their labor, things that have been difficult and expensive have become easier to produce and cheaper. Therefore, price cuts are natural and rational.
Despite this understanding, the prices of basic consumer goods have been rising for decades and the quality is declining. This is because productivity gains need to be felt through a constant monetary base, which is a measure of the process. In a monetary measurement system with a fixed base (such as BTC), productivity gains translate into price declines. However, if the measure of money is tampered with (such as a printing press), prices will rise year by year despite a significant increase in productivity.
With this theoretical understanding, let us turn to specific examples of critics' concerns.
Concern 1: Nominal wages fall
Critics worry that under the BTC standard, falling consumer prices will affect workers' wages and frustrate workers. The problem is that critics have forgotten what wages represent – human time.
With toothbrushes, it is natural that technological advances make them easier to produce every day, but human time is different, it is truly scarce and irreplaceable. While one type of work may be automated, other advances will bring new roles. Work is not limited. Therefore, although the price of a toothbrush should fall as the money supply continues to fall, there is no reason to believe that human time prices will also fall.
The chart below shows the price level in the United States in the 1800s. Look closely at the changes.
As shown in the picture, this is an era of rapid price declines. So, what has changed in wages? The wages have risen. The US Bureau of Labor Statistics states:
- Workers are angry at the decline in nominal BTC wages;
- The actual debt burden of BTC-denominated loans continues to increase;
- Depositors hoarded the appreciation of the BTC rather than investing, making the economic growth weak.
“Overall, money wages are on the rise, while the cost of living is declining. The result of the combination of these two different movements is that real wages have risen sharply.”
Although the supply of labor has increased nearly 10 times since the beginning of the 19th century and has experienced a brutal civil war, the economy has been devastated and hundreds of thousands of people have lost their lives, but real wages have increased substantially.
Now, you might say that the price has fallen so fast because the US is still young and it is the first time it has developed. But we can see that the same trend also occurs in today's technology industry. The price of electronic products has been declining for decades, but companies are still trying to pay competitive wages to their employees. So it is very likely that even if the price of goods naturally declines due to the increase in productivity, the labor cost will remain unchanged or even rise.
But if critics’ fears come true, wages do fall in name, but what matters is purchasing power. It is counterintuitive to say that workers will be frustrated by the ability to buy more and better quality goods.
In contrast, money depreciates every year, ordinary people do not have a safe place to store their savings, and the rich profit from financial assets. This is especially painful considering the phenomenon of “rigid wages”. Below is a chart showing the complete decoupling of productivity and compensation.
By observing the above trends, a terrible consequence can be foreseen – a serious increase in income inequality, populism and social unrest. If critics really care about workers, they will support BTC as a common citizen's savings technology to prevent their savings from being diluted unconsciously.
Worry 2: Increase the actual debt burden
Critics also claim that the actual debt burden of BTC-denominated loans will increase as the BTC appreciates. They worry that this will cause the debtor to be insolvent and the loan becomes impossible. This view is naive – it assumes that BTC will appreciate forever.
Here, it is helpful to know the evolution of BTC as a currency. A new high-quality currency cannot simply enter the world in perfect form – it takes time. In the early stages, BTC will slowly absorb value from traditional value storage methods and gradually rise to the global reserve currency. With BTC's superior currency attributes, it will gain liquidity and market capitalization in competition with other traditional reserve assets, and the initial stage of this price discovery may take decades.
As BTC slowly wins this currency competition, it will also become a reliable standard for accounting and exchange value. In the later period, BTC will become a reliable unit of account because it is more stable than other assets.
Those who are worried about pricing their debts with BTC confuse the timeline. In the early stages, debt should of course not be priced with BTC! However, in the later stages of BTC adoption, once the value is slowly stabilized, the debt will be easily priced and their true value will remain stable.
Worry 3: Reduced investment or spending leads to stagnant growth
Finally, critics worry that BTC will cause economic stagnation as people hoard more and more currencies, rather than investing in businesses. This is another case of confusing the evolutionary path of BTC.
As mentioned above, once the price discovery phase is over, BTC will slowly stabilize relative to other assets. By then, it will serve as a global value constant for communicating prices and making investment decisions. After that, investors will still have the incentive to invest in BTC, and simply holding BTC is equivalent to seeking low-risk interest rates.
This shift will actually promote better investment! Because of inflation, high-net-worth individuals and financial institutions are forced to invest their money in speculation, just to protect themselves from inflation. As BTC works as a non-dilutable storage tool, madly looking for a “risk-free” security tool to circumvent inflation will become history, which will lead to more accurate and more prudent investment decisions.
But what happens when consumption falls? Will people reduce consumption and slow economic growth? Let us look at this study. Even the Fed has concluded that:
“What is surprising is that nearly 90% of the deflationary period did not appear to be economically depressed. In the vast historical context, only the Great Depression (Editor's Note: refers to the economic crisis between 1929 and 1933).”
This is also very intuitive. The price drop does not mean that people will suddenly stop spending! People still have needs and they will spend money to meet these needs. This also applies to non-essential items. For decades, the technology industry has experienced severe price deflation trends, but consumers are still waiting in line for new product launches.
In fact, we should expect that when prices fall, people will consume more because they feel the wealth effect of purchasing power – consumers like to see prices fall. All of Target's products are always "discounted" for a reason.
How does BTC prevent systemic deflation?
Under the BTC standard, the “deflation spiral” that makes mainstream economists sleepless will become less common and less serious. Currency is a system of measurement used by market participants to pass prices. This measurement system is distorted when a currency can manipulate the economy through the central bank's indiscriminate printing of banknotes, changing deposit reserve requirements, and raising or lowering interest rates.
By creating a series of artificial market signals and manipulating credit prices, the inflationary money supply has led to over-leveraging and poorly managed investments. The pricing of risks has become unreasonable. People's consumption may exceed production, and excess market may last longer than without intervention.
The black line represents debt and the gray line represents productivity. From Dario "How Economic Machines Work"
Unfortunately, the rise is bound to decline. Artificially stimulating the economy can lead to a bad investment bubble, which will eventually burst with more painful and more pronounced fluctuations.
- Central banks artificially pushed down interest rates and bought foreign bonds in a big way, triggering prosperity in the 1920s. This intervention led to unsustainable credit creation that eventually led to the Great Depression.
- Japan witnessed this in the early 1990s. At that time, the expansionary monetary policy for many years led to a sharp rise in asset prices, which eventually led to a market crash. In just a few years, the stock market fell more than 63%, and the real estate market shrank by half. Continued interventions have led to decades of slow growth in Japan and the rigidity of the corporate system.
When large financial institutions are free to manipulate money, the real horrible deflation – the sudden collapse of the overconfident bubble in the market – becomes much worse. The short-term interests of elected officials have led central banks and politicians to regularly expand their money supply for temporary benefit, although this has catastrophic long-term consequences.
As Rey Dario pointed out in his book Debt Crisis:
- The 2008 financial crisis was also a deflationary crisis. Large-scale liquidity tightening has completely frozen credit markets and pricing mechanisms. This situation is exacerbated by the loose monetary policy and artificially low interest rates, as well as the collapse of deposits in the highly leveraged European dollar (the US dollar held in non-US banks in Europe).
“In many cases, monetary policy helps to amplify the bubble, not to suppress it. This is especially true when inflation and growth are good and the return on investment is high… In this case, central banks that focus on inflation and growth tend to Reluctance to fully tighten the currency. This happened in Japan in the late 1980s, and in most parts of the world in the late 1920s and the mid-1980s."
To make matters worse, the inflationary money supply also makes it harder to recover after the economy falls. Despite the response, the authorities often immediately rescue the company. Provide short-term assistance again and undermine long-term prospects. As a result, long-term poorly managed zombie companies have been in the economy for decades.
Will BTC end these credit cycles? not quite. But a solid monetary base will prevent the authorities from artificially creating huge credit bubbles and the terrible consequences. Unlike violent volatility, BTC will allow the credit cycle to run smoothly at natural rates and form a consumer economy that is consistent with productivity.
The supply of BTC is not deflationary. Its money supply is fixed. As the world unites around the BTC standards, the new monetary base will promote economic signals in a far-reaching way, bringing unprecedented sustainable and healthy growth. As productivity increases, prices will naturally fall, while avoiding the deflationary spiral caused by artificial currency injection.
The content is for reference only, not as an investment recommendation.
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