Deflationary spiral

This page is a stub. Help by expanding it. Deflationary spiral is an economic argument that propose that a runaway deflation would eventually lead to the collapse of the currency. It is a common criticism made against the viability of Bitcoin.

Deflationary spiral occurs when the price of a commodity increases at some given rate which causes people to hoard it. As people horde the commodity, less and less of it is available thus causing the price to go down even more. In turn, even more people hoard the commodity. Thus a feedback loop or spiral of deflation occurs.

Effects

Deflation, like inflation, includes winners and losers.

The losers are borrowers, especially those who would have to pay principle plus interest rate. Since the value of loan increase due to inflation, that means they will have to pay more in real term.

The winners include anybody who had saved. Thus, an deflationary environment would automatically encourage more people to save for the expectation of increasing purchasing power.

Economic history

The first deflationary phase in Bitcoin's economic history is a phase of economic growth caused by the slashdot effect. From there, we see the the price of bitcoin rose to 0.06 USD. This price level remain stable until early October, when a rally cause the price to touch .50 USD before settling at the .20-30 USD equilibrium.

There will only be 21 million bitcoin in the world, ever. Thus, the expected value of bitcoin rise in correlation with the number of people using it, as well increase in productivity. Further deflation occurs with people losing their wallet, thus all access to their bitcoin. While the destruction of bitcoin never occurs, the loss of key to access it effectively mean that bitcoin can never be used again.

Over the long term, as long as the combination of the two causes hold true, deflation will continue to an absurd level.

Counterargument

Opponents counter that the deflationary spiral is not possible because of the Time Preference theory and the necessary end goal of money; to purchase goods and services.

Opponents had argued that humans will prefer something now rather than latter, all things being equal. Thus, something that happen sooner is more valuable than what happens further down the road.

Furthermore, there is a natural limit to human's time preference. A human being cannot wait indefinitely to not spend money on food, milks, and other goods without suffering some kind of hit to a human being's health.