So if you have an economy which is naturally growing very rapidly for independent reasons (e.g. because there is an industrial revolution happening) then it can outpace the deflation.
But you still have some people hoarding currency because some people have different levels of risk tolerance. One person is willing to build a factory at great risk because there is even greater reward. Another person says give me the steady returns from hoarding deflationary currency.
Getting rid of those returns pushes that person back into the market, requiring them to do something productive with their money instead of just sitting on it. Which is all the more important when there are many productive things to do with it. So the deflation caused growth to be less than it would have, e.g. 15% instead of 20% (in real terms), even if it wasn't enough to turn negative. But it was still a reduction.
And what happens when the economy is only growing at a normal pace and you introduce a deflationary currency?
In practice what tends to happen is that debtors are incentivized to start using alternative currencies because their debt load becomes unbearable otherwise, and then the inflationary currencies drive the deflationary ones out of circulation through Gresham's Law [1]. Hoarders end up holding useless tokens that are eventually demonetized entirely.
The gold-backed dollars of 1873 suffered this attack in two waves. The first was the Free Silver movement of 1892 [2], which sought to allow free coinage of silver currency as a way to create inflation and lower debt burdens for poor farmers who were being exploited by the Northeast's industrial-financial establishment (sound familiar?). This ultimately failed, although it did manage to inspire The Wizard of Oz [3].
The second was the steady inflation of Federal Reserve Notes (i.e. the dollar) from 1914 onwards. This culminated in EO 6102 [4], which made it a crime to privately own significant quantities of gold. Someone who faithfully hoarded gold coins from 1873 onwards would've done great until 1900, okay until WW1 ended, found themselves in the odd position of having money that was worth more on the black market than as legal tender (much like American Eagle gold coins have a face value of $50 today but a market value of about $1200), and then been forced to turn in their gold coins for their face value (effectively confiscating their assets at a loss) in 1933.
I don't have a dog in this race, I just want to add the historical perspective.
I think that Bitcoin already has failed as a currency, outside of black markets. However, that won't stop it from having value: gold failed as a currency in 1933, but is currently worth $1300/oz. I think we'll see another 1-2 Bitcoin bubbles, each with peaks significantly higher than the rest as Bitcoin are taken out of circulation, until it finally falls to Gresham's Law.
I also think that conditions are extremely ripe for a currency crisis in the U.S. dollar within the next 5-10 years. There is a market now for a new currency, as evidenced by the ~3700 contenders (just in crypto alone, not counting in-game currencies for video games or mobile payment networks) launched within the last 2 years. I suspect the eventual winner will be an inflationary cryptocurrency that solves the scaling issues and has a pretty (and fast) UI. Could be Ethereum if they get their act together with Casper, or could be something yet-to-be-invented.
> gold failed as a currency in 1933, but is currently worth $1300/oz
Yes, because gold is a commodity, not a currency.
In fact, if you treat gold as a metal with utility similar to copper, but scale the price of copper proportionally to gold's scarcity, you get a price that is very in line with the actual current price of gold. Since copper's value comes almost entirely from its utility as a metal, this suggests that something similar is true of gold.
That aside, comparing bitcoin to gold makes bitcoin look bad in multiple ways: The analogy is not good, and even if it were good, that would still be a bad thing. The linked article talks about this.
> I suspect the eventual winner will be an inflationary cryptocurrency
Almost certainly impossible. Proper active currency management requires anticipating the public's reaction to the management. Even if an algorithm could do that (in other words, a strong AI which is at least as good as people at understanding human psychology), if the algorithm were public, the public could/would use the algorithm to anticipate changes in currency policy, and that knowledge of the future would change what they do with their money, specifically in the direction of instability. So an open algorithm (a fundamental philosophy of crypto) is fundamentally at odds with the very notion of an actively managed money supply. The linked article talks about this too.
Isn't the bitcoin block reward a form of inflation? Of course the block reward shrinks over time and eventually only transaction fees will be used to pay miners but there is no reason this has to happen. If the block reward instead increased by 2% every year inflation could last forever.
Changing the reward/transaction price/whatever by a certain fraction every year doesn't imply that the price will move by the same amount, due to the original problem mentioned above: If the supply is rigid (i.e. not responding to market forces), then the price will be demand-driven, and demand can/will change arbitrarily, which means high volatility.
To maintain fixed inflation, the supply would have to be actively managed (and I assumed that's what was meant).
> I also think that conditions are extremely ripe for a currency crisis in the U.S. dollar within the next 5-10 years.
Why?
> There is a market now for a new currency, as evidenced by the ~3700 contenders (just in crypto alone, not counting in-game currencies for video games or mobile payment networks) launched within the last 2 years.
That is a stretch. Almost none of these currencies are legal tender, anywhere. There is a lot of scams, pump 'n dump, in this world.
I do agree there are valid purposes. Though those are not necessarily legal.
The black market and international market for example. Something like Monero can be used for sketchy business. It can be used to avoid taxes, to pay for drugs, and to get rid of a weak currency.
For me, a European utilizing EUR and staying in legal waters, no it isn't interesting...
1. Rising indebtedness, both private and public, and concentrated asset ownership. Debtors have an incentive to favor money creation and inflation because it reduces the value of their debt in real terms; creditors have an incentive to favor the opposite. When a small number of creditors hold the loans of a large number of debtors, or when the government itself is a major debtor, there are significant democratic pressures toward monetizing the debt. (Berkshire Hathaway annual reports talked extensively about this in the late 90s and early 2000s and still sometimes do, though Buffett believes this will happen through gradual inflation rather than a crisis.) We've already seen some of this with the political pressures on Janet Yellen and Jerome Powell this tightening cycle.
2. A large injection of money through QE that has so far stayed in capital markets and not made its way to every-day transactions. One of the great mysteries of the 2010s is why the large increase in the money supply did not cause inflation. My explanation for that is that it did - but only in asset markets, like stocks, unicorn startups, CA real estate, Bitcoin, etc, because that is what the people who had money chose to buy with it. This is viewed as wealth inequality rather than inflation. If you fix the wealth inequality - either by government redistribution or by rich people finally choosing to consume rather than invest - you will get the inflation, and may get it very rapidly.
3. Historical perspective: once inflation pressures start, they are very difficult to control, and usually result in a feedback cycle where expectations of future inflation cause people to get rid of their cash more quickly, which makes the velocity of money rise, which makes inflation even worse.
4. General loss of trust in institutions, particularly the financial industry, the government, and the Federal Reserve. Obama's actions in 2009 basically saved us from a total financial meltdown. It did so at the cost of trust - there's now a widespread (and not entirely unjustified) belief that the system is rigged against the common person, because when they make dumb financial decisions they're on the hook for it but when Wall Street makes dumb financial decisions the government bails them out.
5. Greater information awareness - thanks to the Internet - and also the rise of filter bubbles, again thanks to the Internet. The former exacerbates the loss of trust in institutions. The latter allows people who have lost trust in existing institutions to start forming their own, and to recruit other people towards their point of view. Together, they create competition where hegemony previously reigned.
6. The rise of potential technological alternatives. Bitcoin sucks as a currency - it takes 11 minutes to confirm a transaction, the UI is bad, fraudsters and scammers abound, and the network is limited to ~7 TPS. However, all of the elements of a functioning currency are there. People do trust it to maintain its value - 10 years in and people have lost individual Bitcoins through failing to secure their private key or entrusting them to the wrong exchange, but the network itself has never been compromised or rewritten. It's possible (though clunky) to transfer value with it. It's possible to maintain stable identities and records of ownership. Efficiency and ease-of-use can be fixed, and the fundamentals are there.
7. The potential need, in the near future, for computers to act as economic agents on their own behalf without human intervention. Services like Ethereum, Iota, Golem, and Filecoin are fascinating here. It may be that cryptocurrencies end up being foremost for machines to transact in and only incidentally for humans.
But you still have some people hoarding currency because some people have different levels of risk tolerance. One person is willing to build a factory at great risk because there is even greater reward. Another person says give me the steady returns from hoarding deflationary currency.
Getting rid of those returns pushes that person back into the market, requiring them to do something productive with their money instead of just sitting on it. Which is all the more important when there are many productive things to do with it. So the deflation caused growth to be less than it would have, e.g. 15% instead of 20% (in real terms), even if it wasn't enough to turn negative. But it was still a reduction.
And what happens when the economy is only growing at a normal pace and you introduce a deflationary currency?