Deflationary Economy: Myths and Realities

1- What is a Deflationary Currency?

A deflationary currency is one whose purchasing power tends to increase over time. In other words, its value grows over the years, which is the opposite of what we observe in the traditional monetary system.

You might wonder how a currency can gain value over time. This is possible if the amount of currency in circulation grows slower than the productivity of the economy. To simplify, imagine the amount of currency remains fixed. Meanwhile, technological advancements allow humans to produce more and better for less cost.

In this scenario, a constant amount of currency chases an increasing quantity of goods and services. According to the laws of supply and demand, this situation leads to falling prices over time, a phenomenon known as deflation. Consequently, the purchasing power of each unit of currency increases in a deflationary monetary system.

2- The Economic Implications of Monetary Deflation

Deflationary pressure due to technological progress naturally tends to lower prices. However, a common argument against deflationary currencies from Keynesian theory is that if purchasing power increases over time, people will no longer want to buy products and services. If one can become wealthier simply by holding onto their money, it would be better not to buy anything and patiently wait for savings to increase in value. According to this argument, this would lead to a lack of economic growth.

However, a little reflection on the subject easily reveals that such an idea is flawed. Obviously, people will not stop buying products or services just because the value of the currency increases. They will simply buy with a bit more discernment, focusing on what they truly need rather than on superfluous purchases.

Let's take a concrete and current example to illustrate this point: computer hardware. The prices of computer products are influenced by two opposing forces. On one hand, deflationary pressure from technological advancements tends to lower prices. On the other hand, the expansion of the money supply, or "printing money," tends to raise prices. For computing devices like computers, technological advancements in this sector are so rapid that the price decrease due to innovation surpasses the inflationary effect of artificially increasing the money supply through the debt-money system.

In other words, technological progress lowers the prices of computer products more quickly than monetary inflation raises them, which is astonishing considering how rapidly central and commercial banks devalue our currency. Technological products are one of the few categories whose prices actually decrease over time. If we stopped creating money out of thin air, the marginal cost of production would approach zero extremely quickly, giving us access to abundance. For most other categories of products and services, deflationary pressure also exists, but monetary inflation prevents humanity from accessing abundance, as prices tend to rise rather than fall.

3- The Impact of Deflation on Purchase Decisions

Let's take the example of computers to illustrate the impact of deflation. Suppose technological progress leads to a 2% annual decrease in the average price of computers. Thus, a computer that costs €1000 today would cost about €980 in a year.

If I need a computer now, I am not going to wait a year to save €20. The immediate utility of the computer far outweighs this future savings. By delaying my purchase for a year, I would lose the ability to use the computer during that entire period, which is far more valuable than making a small saving.

This example demonstrates that the argument that a deflationary currency would paralyze the economy by discouraging people from buying is unfounded. Consumers will continue to purchase the goods and services they need immediately, without waiting for potential future savings. Immediate needs and benefits outweigh marginal long-term gains.

4- The Unhealthy Nature of an Inflationary Economy

In a deflationary economy, there is a greater incentive to save rather than spend, because people know that the same amount of money will buy more in the future due to productivity gains. In contrast, in an inflationary economy, the incentive is to spend immediately and as quickly as possible, because people consciously or unconsciously feel that their money will be worth less tomorrow. Essentially, a deflationary currency encourages frugality, saving, and long-term planning, allowing individuals to project into the future and make life plans, whereas an inflationary currency encourages rapid spending, overconsumption, and even debt due to the devaluation of money.

The dynamics of a deflationary currency mean that, while people will continue to buy what they need, they will be less inclined to spend their money on superfluous purchases. As a result, overall consumption might decrease, but this could also reduce current overconsumption. Ultimately, this could promote more responsible and sustainable consumption, benefiting both people and the planet.

5- Why Do “Classical” Economists Demonize Deflation?

Many economists claim that deflation would be catastrophic for the economy and must be avoided at all costs. There are two main reasons behind the propaganda of modern monetary theory.

1) The Privileges of Financial Institutions

First, states, central banks and commercial banks hate deflation because it threatens their privileges. These entities benefit immensely from their ability to create money out of nothing. Central banks, for example, have the power to create money ex nihilo and lend it in financial markets with interest.

Commercial banks can also create money when they extend credit to their customers, allowing them to earn interest on money created from nothing. States can finance their budget deficits with debt monetized by central banks. In other words, the central bank creates money and lends it indirectly to the government to fund its expenditures. This ability to create money allows politicians to make costly promises, funded by monetary creation, thereby confiscating the purchasing power of the population.

2) The Effects of Deflation on a Debt-Based System

Secondly, in our current debt-based system, deflation is indeed problematic. If monetary creation stops and prices naturally fall, debts become unpayable, and the financial system risks collapsing. Deflation increases the burden of debts, and since most states are heavily indebted, prolonged deflation could lead to major financial crises.

The problem is not deflation itself but the irresponsibility of states that overborrow, thinking money is free. In a debt-based system, the money supply must continuously increase to avoid system implosion. Inflation is necessary to lighten the debt burden. Ironically, the faster technology evolves, the more money must be created to avoid a crisis.

This perpetual monetary creation redistributes purchasing power from the poor to the rich through the Cantillon effect, creating social unrest and making the system unsustainable in the long term.

6- The Cantillon Effect

The Cantillon effect reveals how the creation of new money initially benefits the rich and large companies before reaching the rest of the population. First distributed to commercial banks, this money is loaned to the first beneficiaries who can invest and spend before prices rise. This price increase then affects workers and less wealthy individuals who receive the money last, reducing their purchasing power. Consequently, the Cantillon effect contributes to increasing economic inequalities by favoring those with early access to new money and owning assets, while others suffer from inflation without enjoying the initial benefits.

Understanding the Cantillon effect is crucial as it highlights the consequences of monetary creation on economic equity. It underscores the importance of fair monetary policies to mitigate inequalities and ensure that all members of society benefit from economic advantages. Additionally, it raises questions about how policymakers and financial institutions manage the creation and distribution of money, emphasizing the need for critical reflection on monetary policies and their implications for the broader population.

7- The Two Monetary Systems

In a debt-based system, a deflationary currency is catastrophic because it worsens the burden of existing debt. In such a system, debt is repaid with money that constantly loses value due to deflation, making debt payments more expensive in real terms. The falling prices also reduce the income of businesses and individuals, making it even harder to repay debts contracted at higher prices. As a result, deflation leads to a downward spiral where debts become unpayable, businesses go bankrupt, unemployment rises, and the economy enters a recession, thus amplifying existing economic problems.

8- The Technological Innovation of Bitcoin

The argument that a deflationary currency "cannot work" holds true within the current monetary paradigm but is false in a non-debt-based system.

Bitcoin is a unique deflationary system primarily because its supply is limited to 21 million coins. Unlike fiat currencies, which can be printed at will by central banks, Bitcoin has a predetermined and finite supply. This intrinsic scarcity makes Bitcoin a valuable digital asset and will potentially lead to a situation where the currency's value increases over time. Additionally, by eliminating the need for trusted third parties and providing a secure and transparent means of storing and transferring value, Bitcoin could foster an economic environment where resources are used more efficiently and abundance becomes accessible to all.

If the Bitcoin network continues its upward trajectory and fiat currencies keep devaluing, Bitcoin could eventually eclipse these currencies to become the dominant global monetary system. As a deflationary currency, Bitcoin possesses intrinsic characteristics that set it apart from inflationary fiat currencies. Its predetermined scarcity and resistance to governmental manipulation make it a safe haven against the loss of value caused by monetary inflation. Furthermore, Bitcoin's decentralized nature makes it resilient to local political and economic crises, offering greater stability and reliability compared to government-controlled currencies.

Consequently, if the current trend continues, with the continuous devaluation of fiat currencies due to the endless monetary expansion by central banks, Bitcoin will eventually be perceived as a beacon of stability and value in an economically unstable world. Individuals, institutions, and nation-states might then seek to accumulate and use Bitcoin as a store of value and a reliable medium of exchange, thereby enhancing its adoption and legitimacy on a global scale.

In conclusion, the more central banks print money, the stronger the Bitcoin system becomes, while fiat currencies grow increasingly fragile. In this context of uncertain economic transition, those who have anticipated by investing in Bitcoin will benefit significantly, having gained a substantial lead. By staying ahead of the adoption curve, you have more time to accumulate this unique, valuable digital asset and prepare for a future where Bitcoin could play a central role in the global economic landscape, offering a unique opportunity to thrive in this emerging economic golden age.

Source & inspiration = Jon Black