Bitcoin Hyper-Deflation, Gold and Silver Report

Monday, December 11, 2017
By Paul Martin

DECEMBER 11, 2017

A meme we have seen in the bitcoin community seems to be gaining traction. Bitcoin is deflationary. That is prices of things, measured in bitcoin, are falling. For example, in spring 2011, gasoline was Ƀ1.00. This week, that same gallon had fallen to Ƀ0.0001875. Gas has gone down by 99.98 percent!

We don’t think that even the diehard bitcoin bugs really believe this.

But it leads to an interesting point. In the past, we have used the analogy of measuring a steel meter stick with stretchy rubber bands. This analogy illustrates that you cannot use something which has a variable length to measure something of constant length. We have also used the analogy of a sinking boat tossing about in the waves of as storm, where people are asking “why is the lighthouse going up and down, but mostly up?” This picture helps visualize the fallacy of using the wrong perspective, the wrong vantage point, the wrong frame of reference.

We need a proper frame of reference for economic values. And now bitcoiners are (mostly jokingly) arguing that bitcoin is the correct frame. In the bitcoin frame, we are experiencing extreme deflation. Since 2011, bitcoin-CPI is -99.98.

Of course, the bitcoin bugs don’t mention the balance sheet implications of this. Suppose a business is doing perfectly fine, except that it uses bitcoin as its unit of account—called numeraire. It made an initial investment of $1,000,000 in 2011 in factory, inventory, etc. As this businesses keeps its books in bitcoin it records this as Ƀ1,000,000 (assuming bitcoin was $1 at the time of the investment).

But by Dec 2017, bitcoin has gone up so much in dollar terms. That means that the dollar and the factory and inventory have gone down so much in bitcoin terms. Assuming no gain or loss in the investment in reality, in bitcoin terms it is now down to Ƀ62.5. This looks like near total loss! It’s not a real loss, of course, just the distortion that comes from a bad choice of numeraire.

And suppose the company had borrowed Ƀ500,000 for 10 years. The loan is still in force, and the monthly payment is still Ƀ6,000. The cost to service this loan has gone up, from $6,000 to $96,000,000. There is no way to keep paying on that loan, so the business goes bankrupt. This is a real loss, which comes from a bad choice of currency to borrow.

The point of this reductio ad absurdum is to illustrate that whatever the right numeraire may be, bitcoin is not it.

Most people—even the gold bugs—argue that it’s the dollar which is the correct frame of reference. Whenever they say “gold went up $10 today” (or down), they are reinforcing the premise that the dollar is the numeraire. In this view, the dollar is the steel meter stick, against which the gold rubber band can be measured.

We have often poked a bit of fun at this, contrasting when they say, “the Fed is printing to infinity, the dollar is gonna collapse” with their promotion of gold as a way to profit—i.e. make more dollars. The very ones that will be worthless very soon.

But there is a serious point here. As a measure of economic value, the dollar is nowhere near as bad as bitcoin. It is unsuitable, though it distorts the picture less than bitcoin does.

Many of my colleagues in the Austrian School would say value is subjective, but, we have just come to the most objective, hard-edged, black-and-white issue of business and economics. It is the line between creating and destroying wealth. Businesses which create wealth should grow. Businesses which destroy should go out of business. If you get this backwards, your whole economy—your civilization—is doomed. It will cannibalize itself (this is a major theme of Keith’s Yield Purchasing Power work).

The Rest…HERE

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