Why Bitcoin (or another deflationary currency) will lead to an economic revolution

In the 1500s, a turning point occurred in humanity. The British and Dutch empires adopted a new concept, that enabled them to take over the world and change it in the process. Their powerful new weapon? The notion of credit, where they abandoned the idea that the old was sacred. By “borrowing” against future prosperity — through credit — they overtook their rivals.

In our lifetimes, we are about to see another transformation. And ironically, due to the opposite reason: where borrowing against the future will be stopped. What’s that got to do with Bitcoin? A lot.

Every man and his dog is talking about Bitcoin and crypto currency. But one thing few people seem to talk about, let alone understand, is that Bitcoin has a fixed supply — specifically, 21 million. Which means that one day, unlike fiat currency, there will be no more “Bitcoins” printed out for the world, which makes it deflationary. If Bitcoin becomes the Store of Value in the world like I optimistically predict,  what will a deflationary world look like? A world where prices, like what you pay for in shops and what you get paid as salary, are decreasing? What’s that going to do to the economy? Four years ago, I made an attempt at saying deflation was a good thing (or rather, didn’t matter) but I didn’t get to the meat. I’m going to make another attempt at it this time (although many other people are still convinced it’s a problem).

Let’s unpack it. First let’s start with the concept of inflation itself.

Here’s a question most people don’t seem to be able to explain. Why do governments, like my tax masters the US and Australia, make 2% inflation a “target”.

Inflation is basically when prices rise and there is a corresponding decrease in value of your cash to purchase — so the US and Australia have it as official economic policy to see prices rises by 2% each year. Short term, it means producers of output get more money, which makes economic output higher. But eventually, labour costs catch up so it’s a neutral impact on the economy. That is, in a best case scenario.

If expectations are managed, this can help jump start an economy short term, useful for elections. But really what’s happening is that long term inflation erodes the value of people’s savings (as their purchasing parity drops) while at the same time it reduces the effective value of debt (for a similar reason). So basically, for a long term “neutral impact” on the economy, debt holders are rewarded and hoarders of cash are penalised.

Debt funds consumption and investment, which grows output in an economy. Savings are a leakage from the economy which do the opposite. So in this sense, this political philosophy broadly speaking, is aligned with growing the system.

Meaning, inflation is evil, but in a good kind of way so we encourage it if we can control it.

Let’s now look at the real question: what’s economic growth?

Economic output
How do you grow an economy? The easy answer is that exports bring cash into an economy, but what about actual global output? If we take out this artificial growth, which is a transfer of cash between economies through trade, what actually creates net growth?

It basically comes down to two things: productivity improvements, which is doing the same thing cheaper (so that extra cash can go to other things), and population growth, which means there are now more people to consume in the economy. More people also means more workers, and remember, labour is a factor of production so the more available people (and time we have), the more we can produce. If we can pair productivity growth to population growth, we get economic growth: as we have more available cash to hire more people, they in turn can produce more output (if we assume the marginal output of labour put to work is higher than the marginal saving from productivity). By the definition of GDP, which is based on consumption, more goods being output and more people consuming means voila: more economic activity.

But that’s not the only thing that can brings cash into a system to fund consumption. Enter debt.

The invention of credit created the world we know today. But a thing that makes me scratch my head is how every government and citizen in this world seems to be in debt. If you look at the estimates, there isn’t one “bank” — every government seems to be in debt. Which basically implies one thing: we are borrowing money that will be paid by future tax, or the future income of citizens.

In the present, this is great: we have another form of cash injection into the economy, but for the future generations, this is effectively a leakage as their earnings are taxed.

Which brings us to the magic of inflation: that debt will get eroded, by a compounding amount, so that it’s practically non existent 2-3 generations from today. Assuming of course, the highway robbery from cash holders continues and inflation is constant.

But not with Bitcoin.

Bitcoin’s economic impact
With a deflationary currency that rules the world, cash holders will get rewarded for saving, as sitting on their economic value will increase with time. Inflation targets will now become deflation targets, but for the same goal of price stability. Instead of prices creeping up each year, they will creep down each year. More significantly,  debt will no longer be in the equation: as debt will only get more expensive over time (due to its purchasing parity) and it’s utilisation will drop.

Shock! Horror! The Kenyesian’s approach by Governments around the world to boost the economy will be eliminated! However, not all is lost. If investments can return a higher rate than what a saver would get hoarding their cash, then investment will still occur in the economy. And with investment, comes not just more cash into a system but also innovation, which might spark productivity improvements. This increases economic output.

Governments will be forced to stop abusing their position to borrow money to be paid by future generations, and instead, investment managers and entrepreneurs who can execute a higher return than deflationary returns, will instead be the custodians of increased economic output.

Which puts creativity, risk taking, and ingenuity, as the sole creator of economic prosperity. Which is how it should be: it’s making the competition of good ideas the thing the drives us forward.

In the process, this will make creativity the new scarcity, which is a powerful concept because it is less scarce than gold or fiat currency today. If Bitcoin or another currency with a fixed supply becomes the Store of Value in the world, this will usher in a new economic age that will be more pronounced than what the invention of credit did for the world.

Contrary to what people say, Bitcoin doesn’t have a deflationary problem: it’s actually got a built-in feature to unlock human potential, by strapping a rocket ship to our economy.

4 Responses to “Why Bitcoin (or another deflationary currency) will lead to an economic revolution”

  • Great writeup- I’m also excited about this. In fact, I posted something along these lines on LinkedIn recently: https://www.linkedin.com/feed/update/urn:li:activity:6321564727835262976

    Someone commented: “why should the amount of credit in an economy be linked to an arbitrary number of 21m Bitcoins?”. i.e. a non-fractional cash system like Bitcoin will lead to unnecessarily high interest rates and therefore an inefficient economy. He has a point. Wonder what your thoughts are on this?

    • The whole concept of fractional cash system blows my mind. Isn’t that why we had the financial crisis?! These banks are creating loans out of thin air!

      Aligning lending to actual cash reserves, which yes, will lead to higher rates due to competition for a more ‘limited’ pool. But also, what is it that is putting demand on that debt? If no one could get a bank loan to buy a “home\” or didn’t want to shoulder the interest, that would lead to a corresponding decrease in the value of real estate. The market would adjust. It’s why answers like this are hard because the entire system gets impacted and there’s not simple answer.

      So yes, he’s right interest will be higher: that’s the point. But the issue of less capital” going around is the real underlying issue he alludes to and to answer this, this needs to be looked at a bigger picture of sustainable debt, inflation, etc. Right now, we’re just passing the buck.

      Less borrowing is going to definitely reduce economic activity. But that’s also why maybe the problem is that we define progress on a ‘bigger’ economy — eventually, things will plateau and growth will no longer be possible to meet this “growth fetish”. So before we hit this crisis, which will happen in the next century due to birth rates declining (Japan and Italy are going to be an interesting to watch for this reason), we need to better way to measure progress.

      And so by changing the equation of what is progress, we change the inputs. And this doesn’t mean he’s wrong about the higher interest rates, but he’s wrong it being an inefficient economy — it’s only inefficient for the current house of cards we have as a system.

  • If/when markets – and the people (consumers, savers, investors, borrowers, et. al. – have more than one cryptocurrency to buy/sell/save/invest, why would this occurrence result in deflation? With no restriction on the number of cryptocurrencies in circulation (a parallel is the world’s fiat currencies), people will adopt cryptocurrencies other than Bitcoin to purchase goods/services, save, invest, etc.

    In my opinion, this anticipated future reality resembles today’s usage of fiat currencies by global markets and the people who participate in them.

    • It is an interesting point you raise, given countries control the cash rate which impacts lending and inflation, as well as being the local store of value.

      My simple response is that it’s all relative. Right now, the greenback is the reserve currency off the world and economic statistics are quoted in USD not to mention directly impact some dollarised countries. If they became quoted in BTC, that would certainly change the perception of where the numbers are.

      On the assumption BTC becomes the global store of value, this is a shift in dynamic on the global economy that will turn everything on its head. Case in point is internet commerce: why bother with national currencies? Things will gradually start getting quoted in BTC, like what already happens in crypto exchanges alongside the USD. So pricing with be evident there.

      If BTC does this, it will become the global ‘cash’ of the world. If it becomes the standard for international trade, I think it’s not going to have a parallel that we can equally compare to.

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