Deflation and Bitcoins

WheelbarrowAn April 11, 2013 article in The Atlantic argued that bitcoins are not presently a currency, and that it “won’t be one until it has a central bank.”  According to the article, a serious problem with bitcoins as a currency is that an economy using bitcoins would be subject to a “massive deflationary bias.”  (See the article at http://www.theatlantic.com/business/archive/2013/04/bitcoin-is-no-longer-a-currency/274859/).

 Do bitcoins have a deflationary bias?  Let’s look at some numbers. 

 For starters, consider the 27-year period extending from now until 2040.  Presently there are roughly 11 million bitcoins in circulation.  By 2040 the amount in circulation will be 21 million.  With compounding, to get from here to there the average annual growth rate of bitcoins in circulation will be 2.4 percent.  Now, consider that growth in real GDP happens at a rate of roughly 3 to 3.5 percent per year.  If money (bitcoins) are growing at 2.4 percent and real GDP is growing at 3 percent, then one might expect prices (when measured in bitcoins) could be falling at 0.6 percent per year—hardly a “massive deflationary bias.” 

 Beyond 2040 the supply of bitcoins is fixed at 21 million.  If real GDP is growing at 3 percent, and the money supply is fixed, then prices might be expected to drop at an annual rate of 3 percent. 

 But there is a serious problem with the forgoing analysis.  That is, even though beyond 2040 the supply of bitcoins is fixed, the velocity certainly isn’t.  Bitcoins can be transferred between people at the speed of light.  The quantity of money in circulation may have been an important consideration back when currency had to be physically transported from point A to point B.  But when money can move at the speed of light, the physical quantity is circulation becomes a non-issue.  Whether prices when measured in bitcoins will ultimately rise or fall depends equally on the money supply AND its velocity, and nobody knows what the velocity will be.

 However, one thing is certain:  bitcoins cannot be printed up by central banks.  And, contrary to what appeared in The Atlantic, this is their biggest strength!  Governments working together with their central banks are able to steal real output from the private sector through running the printing presses.  Thankfully bitcoins are not controlled by self-interested politicians, central bankers, and greedy government bureaucrats, which is precisely why Capital as Money will soon be priced and sold in bitcoins.

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