Aside from its other desirable properties, the bitcoin protocol includes a schedule for future bitcoin creation, which can inform the inflation expectations of rational consumers in a much more reliable way.
The Austrian school of economics defines inflation as: “A general increase in themoney supply.” Not a general increase in prices, as Keynesian economists define it. ”One of the effects that may accompany inflation (and is sometimes confused for it) is a rise inpricescalledprice inflation.” This can also occur as a result of supply shocks, with fewer goods or services being available.
Deflation is antithetically defined as a general decrease in the money supply; as the proportion of money, compared to ‘things to spend it on’ falls. And similarly price deflation can also occur as a result of an abundance in goods and services.
Austrian economists believe that prices will tend to proportionally reflect the supply and demand for money, goods, services and other assets in an economy. But accept that daily prices are subject to a myriad of other influencing factors. Price deflation can even occur during and after a monetary expansion. Take the recent fall in oil prices as an example.
The general public may not recognise price inflation resulting from the Quantitative Easing (QE) policies of the major central banks of the world. The new money is being injected directly into financial instruments like government and corporate bonds. Then it enters the property and stock markets, driving asset prices higher.
The average consumer has little exposure to this. Despite housing costs increasing for renters and large capital gains for property owners, they are more concerned with the price of food and energy rather than a rise in stocks and bonds.
But many central banks are pursuing the policy of selectively expanding their money supplies, with the expressed goal of achieving higher price inflation. Their mantra for the justification of this policy is that inflation is good, and deflation is bad.
Given that almost every developed nation is currently struggling with high unemployment and falling real wages, a general price deflation would likely be a relief to struggling individuals and families – by lowering the cost of living. But the assumed need for ever increasing prices is still used to justify QE.
When we consider the inflation/deflation schedule for government issued currencies as a whole, there are two encompassing factors: The quantity of fiat money will increase quasi-predictably as commercial banks ride booms and central banks attempt to soften busts. And the global production of goods and services purchasable with these currencies should be fairly stable.
This implies an inflationary forecast; It guarantees that citizens will lose real purchasing power with their income and savings; and that the redistribution of value, arising from the creation of new money in particular sectors like finance and property, will feed luxury markets and add to wealth inequality.
Bitcoin represents an alternative, decentralised monetary system, run by general consensus with an open accounting ledger. It presents no moral hazard because it requires no trusted third party, and treats all users equally. It gives no one person or group the opportunity to arbitrarily reassign value from one person to another.
Aside from its other desirable properties, the bitcoin protocol includes a schedule for future bitcoin creation, which can inform the inflation expectations of rational consumers in a much more reliable way.
Bitcoins (BTC) are created each time a user discovers a newblock. The rate of block creation is approximately constant over time: 6 per hour. The number of Bitcoins generated per block is set to decrease geometrically, with a 50% reduction every four years. The result is that the number of Bitcoins in existence will never exceed 21 million.
Right now, there are just over 13.75 million BTC in existence. This amount is increasing at a rate of just over 1.31 million per year. About 18 months from now, in summer 2016 when there is approximately 15. 7 million BTC in existence, the rate of bitcoin creation is set to halve, to around 0.66 million per year. The annual inflation rate is set to drop from about 10.5% to 4.2%.
So, consider the substantial headwind of over 10% inflation that bitcoin has endured this year, as the price made a fairly controlled decline from the heights of late 2013. And consider that when this inflationary pressure is halved in summer 2016 there will be 50% less new bitcoin available on bid and offer exchanges.
The rate of bitcoin creation is having an entirely predictable downward influence on the price of bitcoin, not dissimilar to the creation of government currencies. The difference is that bitcoin’s inflation rate is set to decrease to zero on a predictable schedule over time.
If we consider a scenario where bitcoin reaches full global acceptance, and is the default payment method of the world, then the protocol promises an inflation and deflation neutral future. Once the number of bitcoin in existence reaches its intended maximum of 21 million, there will be zero growth in the money supply.
This implies that a growing economy will have a period of falling general price levels. During which, the average consumer has more disposable income and savers are rewarded with increasing purchasing power. Conversely a contracting economy will feature price inflation.
The future inflation rate of fiat money world-wide is more uncertain, though it is almost certainly much higher than that of bitcoin. As central banks take turns to ‘Ease’ in ever-growing nominal increments.
The second main determinant of the bitcoin price; the quantity of goods, services and assets purchasable with bitcoin, has started very small and could get very big. This implies huge deflationary potential and invites all sorts of exponential predictions of bitcoin value, reliant on continued increasing adoption.
If bitcoin could capture a sizable share of all global transactions, then the proportion of bitcoin to purchasable goods, services, and assets would become very small; demanding that each unit of bitcoin account for more value in the market.
Bitcoin appears to be on a steep adoption curve. But in order to realise its deflationary potential, users must also be spending bitcoin. That means buying it or earning it, and then being willing to part with it.
This happens increasingly when the bitcoin price is rising, and price deflation is already occurring. Leading up to Christmas 2013, when the bitcoin price was at all-time highs, some users cashed out while others took part in a heavily discounted holiday shopping spree. Taking advantage of the increased buying power.
If every upturn in price like this leads to good deals, more media coverage and new users, then each temporary overvaluation of bitcoin could result in a new lower resistance level and set the stage for another, bigger upward price event in the future.
Many informed bitcoin enthusiasts predict that faster-paced adoption, eventually leading to a sustainable level of demand, will correlate in some way with high volatility in fiat currency markets and steeply rising price levels denominated in fiat currency.
If world currencies become sufficiently volatile it will cause capital to flee currency markets, and crypto-currencies are beginning to look more and more like a viable destination for it.
