Bitcoin often is associated with being a hedge against inflation. We have heard a lot about money printing, devaluation of fiat currencies, hyperinflationary scenarios and the like concerning “HODLing” Bitcoin.
But what about deflation?
I once wrote about BTC and BSV in a recession, but have not dived deep enough into the topic of deflation. That is why I caught up with Bitcoin thought leader and speculator Daniel Krawisz to discuss deflation and Bitcoin in depth.
Hi, Daniel! Let us talk about Bitcoin and “blood in the streets,” a famous quote about investing in times when prices are very low. First of all, what is deflation?
Daniel Krawisz: There are two definitions of deflation. For Austrians, deflation is a negative change in the money supply. More commonly, deflation is a lowering of all prices. I will use the terms supply deflation and price deflation to differentiate them.
Supply deflation can happen because of fractional reserve banking when people use bank notes as money. A bank note was the progenitor of our fiat paper system that we have now. It was paper that was redeemable for a sum of gold at a certain bank. If the bank does not have 100% reserves, then the bank is insolvent, and risks being proven so if too many people redeem their notes at once. When this happens (which it will inevitably) all bank notes that were not redeemed before the gold ran out become worthless. This is very bad because a lot of people who believed they had money find out that they really don’t.
When this happens, we have price deflation because there is all of a sudden less money chasing after the same amount of goods. However, there are many causes of price deflation. One of them is economic growth. When this happens, price deflation is very good. It lets everyone who has saved money partake in the growth of the economy. Goods become cheaper which means everyone is wealthier.
In politics, we frequently see words used in a slippery way. This happens because of agendas that are best promoted using confusion. Originally deflation meant supply deflation. As soon as economists figured out that this was bad and the word got a bad connotation with the public, malicious actors who wanted to inflate started talking about deflation in terms of prices as if that is always bad, when really it is only bad for debtors and good for savers. Governments are always the biggest debtors so they hate deflation and they produce tons of propaganda to convince people that it’s horrible if all prices go down when it ought to be almost self-evident that it’s good to pay less for things.
Another cause of price deflation is the collapse of an asset bubble. I think this may be what you were imagining when you asked about deflation. All processes happen in the market because of learning. In markets there can be illusions which make it appear as if people believe something that they really do not. When the illusion fails, a big move can happen.
In markets, we want to do what other people are thinking but have not done yet. It is a contest to be ahead of the rest. Thought does not follow a predictable pattern. If it did, then there would be nothing that is unknown. If there was no unknown, there would be no need for thought. Asset bubbles happen because people come to believe in predictable patterns. They tell themselves that they know things that they really have no way of knowing. They all stop thinking together and follow a predictable pattern. No pattern is sustainable forever, but they can go on as long as there are more resources that can be put in them without understanding that those resources are lost. We can see this with BTC. People who buy BTC are investing in an economy that can have no growth. This is obviously unsustainable, but they believe they are right because the price keeps going up.
As Newton said, “I can calculate the motions of the planets, but I cannot calculate the madness of men.” Newton said this because he lost most of his money in an asset bubble of the South Sea trading company in 1720. Newton remembered this too late. All speculation is a journey into the unknown. The way to be successful at it is to understand things that have never been seen. We must go into markets awake like the Buddha, aware of our ignorance like Socrates, and never forget that “The dao that can be named is not the eternal dao.”
Bitcoin was invented in an inflationary environment and has not yet experienced a deflation since its inception. What about Bitcoin in a deflation?
Daniel Krawisz: That’s true if you’re thinking of Bitcoin as a speculative asset rather than as money. If we’re thinking of Bitcoin as the money supply, then supply deflation of Bitcoin isn’t possible because all coins can be retrieved eventually. However, price deflation is possible and that would be a very good sign of economic growth if the market wasn’t acting totally crazy like it is now. Before the splits, Bitcoin was deflationary even though the economy was being destroyed by communists. This tells us that Bitcoin investors don’t understand that communist economies are unproductive. Eventually the market will come to understand the truth.
If you’re thinking of fiat as money then we can have asset bubble crashes, which we have seen before in Bitcoin. What we are looking at now is perhaps the biggest bubble in history, so we are perhaps looking forward to a crash in Bitcoin that is bigger than anything we have seen before.
What is inflation? Are we talking about money expansion or supply shortage? How to tell the difference? And can it be both?
Daniel Krawisz: Once again, there are two meanings of inflation. Supply inflation and price inflation. In a similar vein, propagandists want to talk about price inflation whereas people who really want to understand things talk about supply inflation.
There is never a shortage in the supply of money. Money does not have any set market value, no matter how much people want it to. If people demand money more than goods, the value of money simply goes up. As I explained in [previous interviews], money can be thought of as an investment in the other entrepreneurs. If there isn’t enough money, that means the entrepreneurs are undervalued and you would expect eventually that the money needs to become more valuable relative to goods.
A large fraction of economists are employed by the government and their job is to fool themselves into believing that everything the government can do to exploit people is good for the economy. The idea that there is not enough money is used to justify inflation.
In our interview on Bitcoin and gold, we talked about hoarding gold and hoarding Bitcoin. Is a deflation basically hoarding money instead of spending it?
Daniel Krawisz: As I discussed in that interview, hoarding is not a valid economic concept. Hoarding is a term that is used by people who don’t believe anyone else could be smarter than them. They try to say that other people are irrational by diagnosing them with psychological problems when really, they don’t know the future and they don’t know for certain what is intelligent.
You can say that deflation is because of holding rather than spending, but that is not a deep understanding of real causes. People do not want to hold cash for no reason. They do it because it serves their purposes in some way. Why are they doing it? The market is a game and you cannot understand it without thinking about strategy. In the world there are many manipulators who want you to forget this so that they can control you.
You can only understand why anything happens in markets by understanding what kind of future people are imagining. The real causes of market moves are beliefs about the future. Over time, people who are wrong about the future lose money. Thus, the market is a system that rewards those with understanding and punishes those without it. This is why I say that capital markets are a future prediction contest.
Economics alone is not sufficient to make money on the markets, although it is important. Each real-life situation is different and different things are important. Successful trading requires the whole brain and all knowledge. Economics alone can never tell you enough about a specific situation. People who want to control everything don’t like being aware of their own ignorance. They always call people stupid who won’t do what they want when really they may well be doing the right thing.
How does the economy get out of a deflation, or in other words: when and why is it that people stop hoarding money and spend it again?
Daniel Krawisz: The value of money has to do with new information. If there’s a lot of new information then you want to hoard money. Entrepreneurs are the most important cause of new information, so that’s why I say money is an investment in the other entrepreneurs. People stop hoarding when they stop believing that there’s something important that they don’t know yet.
This happens as an economy approaches equilibrium. As Mises showed, in an evenly rotating economy, the value of money is zero! That is not something that I want, nor would it be something fun for anybody. I want growth. If we want growth, we need to stop thinking of deflation as a bad thing. Deflation has different meanings and different causes. This confusion has occurred because of manipulation from people who are in debt who want us to believe that their misfortune is our misfortune.
Is a bubble only possible in an inflationary environment, or can bubbles also occur in a deflation?
Daniel Krawisz: A bubble is when everybody convinces each other that something is valuable, and it will always go up when really it won’t. A bubble can be self-sustaining for a while because rising prices can attract more people which leads to more rising prices, and so on. Inflation is not required for this, but it helps because people can mis-ascribe the cause of rising prices to something about the goods rather than about the money.
If deflation is caused by the collapse of an asset bubble, then maybe there can be a different bubble that is being blown up at the same time. If deflation is economic growth, then you would expect a bubble to be something that is in conflict with deflation, but they could still happen together. There just wouldn’t be as much deflation. If deflation is a bank panic, then that is something that you would expect to cause asset bubbles to collapse.
In our interview on Bitcoin and speculation, you explained differential knowledge as the key to being a successful speculator. So it is safe to say you are not going to share your potentially differential knowledge with us concerning deflation. In that interview, you warned us to not listen to people sharing their speculative insights. Therefore, we cannot trust you! But is there more deception concerning speculation in an inflationary environment than in a deflationary one?
Daniel Krawisz: In economics, deception is everywhere. I think that inflation is deception, so yes there is more deception in an inflationary environment. Inflators must surprise people with new money, or they cannot benefit from it.
I’m glad you brought up the problem of not trusting me. We can solve the problem of deception with proof-of-work. Deceivers depend on cheap talk. They can’t eat until after they have deceived a victim, so it is very bad if talking is costly. People with real knowledge create value first and can then afford to pay to talk and you would do it because you wanted a better society. If you prove that you have converted free energy into heat, you suggest that you are connected to the fundamental nature of the universe. That is not absolute proof, but if everyone who claims to know the truth would put themselves in a proof-of-work contest, the truth would be much easier to find.
Today, the truth is what we need more than anything and we must develop the means of finding it quickly or we will all be murdered. The problem is so very big and the solution so simple but people just don’t believe that we need it. You really shouldn’t listen to anything I say without partially inverted hashes.
Is deflation some sort of “market catharsis” that exposes “false prophets” concerning their statements on speculations from the past, especially those who intentionally lied to deceive other speculators?
Daniel Krawisz: If deflation is caused by economic growth then no, that is not what it is. If deflation is a bank panic or something caused by the collapse of an asset bubble, then yes.
As of right now, Bitcoin itself is still inflationary, as more and more Bitcoins go into the hands of people each time a block reward subsidy is being paid out. Why is it that people say Bitcoin is “deflationary money” then?
Daniel Krawisz: Bitcoin is not inflationary. The bitcoins that have not yet been distributed are owned by Satoshi, although they are set aside under a unilateral contract to be distributed according to the original rules. This was important in Dr. Craig Wright’s case with the Australian Tax Office, so he says, because they tried to put him in bankruptcy. That would have meant that they could claim those bitcoins as a tax payment.
Thus, all satoshis existed at the outset of Bitcoin. The undistributed coins cannot be spent for the moment, but they are still priced in. In general, inflation does not work if it is not a surprise. That is why the Federal Reserve is so coy. If they followed a schedule that was set long in advance, they would not be able to gain from it.
I know the difference between issuance and distribution of coins, and I also know about the unilateral contractual offer by Satoshi Nakamoto. However, even though all Bitcoins are already issued, they are still being distributed and add to the number of the supply right now. So at the moment, isn’t there kind of a money expansion in Bitcoin?
Daniel Krawisz: No, it is not. When we all have knowledge of the future, we do not have something we can speculate on. Knowledge of the future distribution of Bitcoin means that the newly distributed coins are priced in already.
We would not expect price inflation because people who would otherwise have saved coins would substitute some hashpower for coins in order to claim some of the future unclaimed coins. As those coins were distributed, there would be a greater preference for saving over mining. That would counteract price inflation from more coins being in circulation.
Remember, the cause of everything in markets is ideas about the future. If people know the entire future release schedule of Bitcoin and know that it can’t be altered, then they will not act the same as if they are surprised with inflation from the Federal Reserve.
If Dr. Wright had lost his case with the ATO, if he had been forced into bankruptcy and the undistributed coins had been confiscated, then we would have seen something like inflation because those coins would have gone on the market before anybody expected them to.
In our interview about Bitcoin and transaction processors, you said that transaction processors should seek Bitcoin instead of fiat money. Let us apply that to a deflationary scenario though—should transaction processors seek Bitcoin in a deflation, too?
Daniel Krawisz: A function of money is to distinguish between a profit and a loss. Seeking Bitcoin means that your entrepreneurial goal is to gain more bitcoins than you had before. You could do this by accepting dollars and then buying bitcoins. My concern with this is that you could lose out if bitcoin goes up a lot in fiat before you have a chance to buy it. However, if you are very good at the market in fiat over bitcoins, then maybe that’s what you want to do. If bitcoin is going down in terms of fiat, then you would just want to wait a bit before you buy in.
If you ask me, understanding the market is the first thing about any bitcoin business so this is how everyone should be thinking. A great thing about bitcoin is how the value changes with the growth of the market. That makes it more challenging to be an entrepreneur, but it makes the economy much better. Everyone must take the overall growth of the economy as their baseline, or they suffer a loss. That is not how dollars work because of all the inflation. It causes people to waste resources trying things that aren’t very good who would be more likely to just sit around in the Bitcoin economy. Then those resources would go to people who know what they are doing.
I just realized that whenever I think of a deflation, I think in terms of fiat money as a measuring stick for falling prices. When we take Bitcoin into consideration though, we have two sorts of money: fiat money and Bitcoin. Help me to understand how to actually grasp deflation when we have two competing forms of money. Conventionally, a deflation would be seen as lower fiat money prices for goods and services—but does that necessarily mean Bitcoin lose its value, too? Or can we face a scenario where we have a fiat money oriented deflation, but with no effect on Bitcoin?
Daniel Krawisz: It’s a competition between two groups of entrepreneurs over who can grow their economy the most and who can offer more opportunity.
If we measure goods and services in Bitcoin instead of in fiat money, could we use transaction volume as an indicator for whether we have a deflation or not? In a deflation measured by Bitcoin instead of by fiat money, decreasing transaction volume would mean people are exchanging less and less, whereas increasing transaction volume would indicate people are not hoarding but using their Bitcoins. What do you think?
Daniel Krawisz: No, those are two different things. The value of money has to do with expected unknown opportunity whereas transaction volume has to do with past realized opportunity. The way we would measure price inflation or deflation is to look at whether prices in satoshis are overall going up or down.
We would expect increases in the value of bitcoin to be associated with future transaction volume, if the market was rational. If there is going to be more opportunity, we would expect deflation first. This would happen as a combination of more capital goods on the market and lower prices as people tried to hold more cash. Transaction volume would follow as the new opportunities that people had expected would be realized.
Let us get back to “blood in the streets.” If you see blood in the streets speculation wise, how do you know whether it is just the beginning or the end of the blood that is going to occur in the streets? How do you measure that “amount of blood”? It could look like “blood in the streets,” but in reality it could only be the first gush of blood.
Daniel Krawisz: When there’s blood in the street, people are apt to imagine things are worse than they really are. Remember, Mr. Market is manic depressive. However, if people were to become a lot less anxious, maybe they would underestimate the problem when there’s blood in the streets, so then you should sell.
It’s about what you know about the real world that other people don’t know. Differential knowledge is really what this is all about.
Are you looking forward to a deflation?
Daniel Krawisz: I’m looking forward to economic growth. If we have deflation because of that then yes I’m looking forward to it!
Are you preparing for a deflation?
Daniel Krawisz: Yes, I am prepared for deflation.
What if the “blood in the streets” is your own blood?
Daniel Krawisz: Then you have failed to predict the future correctly. Future prediction is a tough game, but people who try to escape it don’t live full lives. Your brain is the only one that works for you, so you can’t rely on other people to do it for you. I’m trying to enjoy life, but it is very hard right now.
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