• Tag Archives inflation

  • Why Bitcoin Is Technically an Inflationary Currency—Even Though Its Purchasing Power Is Increasing

    Posted on by Azrael 1 Comment

    Inflation is commonly defined as “a general increase in prices and fall in the purchasing value of money.” For example, if a six-pack of beers cost $8 last year, but this year the same six-pack costs $16 then the annual inflation rate was 100 percent. This is because the price doubled for the same quality and quantity of beer.

    To put it in perspective, the most famous hyperinflations occurred in Zimbabwe and in Germany. In 2003, Zimbabwe’s monthly inflation rate hit 7.96 x 1010 percent, and in 1923 the German government’s hyperinflation caused the exchange rate to rocket to 4.2 trillion German Marks to one U.S. dollar.

    Using the common definition, Bitcoin is deflationary because Bitcoin’s purchasing power increases over time.

    However, the traditional definition of inflation, according to the British Currency School, was an increase in the supply of money that was unbacked by gold. According to Reinhart and Rogoff’s This Time is Different, governments have been inflating currency over the past 800 years.

    Originally, governments would inflate the currency by debasing gold coins. During the 20th century, government inflation technology advanced to printing presses, and currently, governments are able to inflate the monetary base by digitally creating money by updating internal databases that track fiat money, which is predominately digital.

    Using the traditional definition, Bitcoin is inflationary because the supply of Bitcoin increases over time.

    Gold is considered the ultimate store of value because of one specific characteristic: scarcity. No person or group can will gold into existence. Instead, the supply is controlled by nature. Figure 1 (above) shows the supply of gold has had a stable inflation rate. The creators of Bitcoin designed its inflation rate to mimic gold’s stable inflation rate.

    Figure 2 (below) shows the circulating Bitcoin since its creation in 2009. As the inflation rate decreases, the price for each Bitcoin should increase, ceteris paribus. Bitcoin’s inflation rate was hardcoded into the software that operates Bitcoin. Hardcoding Bitcoin’s inflation is similar to Milton Friedman’s K percent rule that called for an algorithmic and regulated inflation rate that would eliminate human-error and the temptation to manipulate the monetary base for political reasons. However, Bitcoin’s inflation algorithm was designed to make Bitcoin even scarcer than gold.

    There is a fixed amount of 21 million Bitcoin that can be minted, which means that no coins can be minted once this amount is reached. Approximately 80 percent of the total amount of Bitcoin has already been minted. Bitcoin’s algorithmic inflation rate since 2010 is displayed in Figure 3 (below) and is explained in the original white paper written by Satoshi Nakamoto.

    “To compensate for increasing hardware speed and varying interest in running nodes over time, the proof-of-work difficulty is determined by a moving average targeting an average number of blocks per hour,” Nakamoto explained. “If they are generated too fast, the difficulty increases”.

    As of July, the inflation rate of Bitcoin was 4.25 percent. The difficulty re-adjustment makes it impossible to simply mine more Bitcoin by allocating more computer resources to the network. As more people try to mine Bitcoin, the software automatically increases the difficulty of successfully mining a Bitcoin and vice-a-versa.

    Once the inflation rate reaches zero, miners will no longer be able to earn money from minting newly created bitcoins. Instead, transaction fees will have to increase or the number of transactions will have to increase. The last edition of the Crypto Research Report contains an in-depth explanation of how transactions are confirmed on the network and how miners earn income by confirming transactions and minting new coins.

    Although Bitcoin and gold are currently inflationary monies, according to the traditional definition of inflation, their inflation rates are predictable and constantly decreasing. Similar to gold, Bitcoin’s annual inflation rate will eventually reach zero percent.

    According to the mainstream economic definition of inflation, Bitcoin is deflationary because the purchasing power of Bitcoin increases over time. Currently, Bitcoin’s purchasing power is extremely volatile, although, this is expected to stabilize in the long-run. Since Bitcoin’s total supply is fixed, Bitcoin’s purchasing power will continue to grow slowly over time if demand continues to increase.

    Source: Why Bitcoin Is Technically an Inflationary Currency—Even Though Its Purchasing Power Is Increasing – Foundation for Economic Education



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  • Did You Know about the Great Hyperinflation of the 17th Century?

    Posted on by Azrael 1 Comment

    The oldest trick in the monetary book is cheating the people by debasing the coin or currency. It goes back at least as far as the Eighth Century B.C. when the Jewish prophet Isaiah chastised the Israelites for doing it. “Thy silver has become dross, thy wine mixed with water!” he admonished.

    Reputable private issuers of money, when governments don’t ban them for self-serving reasons, might be tempted to dilute the value of their product. Their incentives, however, tend to run strongly in the other direction.

    If their product gains in value, they make money (literally and figuratively). If they debase it, they might be prosecuted for counterfeiting or fraud. But in any event, customers will flee to competitors happy to “make money” by offering it in a more trustworthy form.

    When entrepreneurs and willing customers shape the framework of a market, the famous Gresham’s Law works in reverse: the good money drives out the bad.

    Similarly, because you prefer fresh eggs to expired ones, or use an iPhone now instead of a walkie-talkie, the inferior product disappears. But when political monopolists backed by the coercive power of government are in charge, the quantitatively-eased stuff is foisted on you whether you like it or not, while the good alternatives are driven overseas or underground.

    Kipper and Wipper

    I thought I knew the low points in the interesting history of monetary corruption until I came across this fascinating article from Smithsonian magazine. It’s about a brief hyperinflation in 17th Century Europe at the start of the Thirty Years’ War.

    Titled “Kipper und Wipper”: Rogue Traders, Rogue Princes, Rogue Bishops and the German Financial Meltdown of 1621-23, the article’s author (historian Mike Dash) claims that this instance of “monetary terrorism” may in fact be “the most bizarre episode in all of economic history.” It arguably yielded the Western world’s first full-scale financial crisis.

    The German terms “kipper” and “wipper” derive from two nefarious practices: One is clipping coins then using the scrap to make new ones, or melting coins into a cheapened mix of precious and baser metal. The other is rigging the scales so that recipients of coinage so debased could be deceived.

    And if you’re not sure what the Thirty Years’ War (1618-1648) was about, just think of it as the most destructive of the many European religious wars. Eight million casualties resulted from a Catholic vs. Protestant conflict that ballooned into a continental power struggle between the royal houses of France, Spain, the Low Countries, and some 2,000 German microstates of the fracturing Holy Roman Empire. In those German territories alone, no less than 20 percent of the population perished.

    In early 17th Century Europe, the minting of coins was typically the exclusive prerogative of kings and princes, which they often delegated to their well-connected cronies in local governments, the church, or even private business. On the eve of the War, in 1617, thirty mints operated in Lower Saxony alone, according to Peter H. Wilson in “The Thirty Years War: Europe’s Tragedy.” Debasement, however, was rare—until the financial demands of the war pressed governments to find new sources of revenue. The crisis and depression spawned by the five-year hyperinflation (1618-1623) is known in German as the “kipper-und-wipperzeit.”

    The Polish mathematician and astronomer Nicolaus Copernicus is universally acclaimed for his assertion that the sun was at the center of the solar system, not the earth. Less well-known are his important contributions to monetary theory, made just a century before the kipper-und-wipperzeit. If this Copernican observation had been heeded, perhaps the folly of what I’m about to tell you might have been avoided:

    The greatest and most forbidding mistake has to be when a ruler tries to make a profit from the minting of coins by introducing and circulating new coins with an inferior weight and fineness, alongside the originals, and claims that they are of equal value.

    The Debasement Begins

    Desperate to raise cash and secure material for war, many of the German states in 1618 resorted to the debasement of coinage. They clipped and they melted. At first, they adulterated their own coin but then discovered that they could do the same to that of their neighbors too.

    They would gather up as much of other states’ coins as they could, melt them down and mix in cheaper metals (most often copper), and then mint new ones that looked like the original but in fact were cheap counterfeits. Then they would send them with couriers back to the other states in the hope of passing them off on ignorant and unsuspecting citizens. The couriers would return with good coin and/or wagon loads of food and supplies.

    Mike Dash noted in his Smithsonian magazine article that just about everybody got into the act:

    While it lasted, the madness infected large swaths of German-speaking Europe, from the Swiss Alps to the Baltic coast, and it resulted in some surreal scenes: Bishops took over nunneries and turned them into makeshift mints, the better to pump out debased coinage; princes indulged in the tit-for-tat unleashing of hordes of crooked money-changers, who crossed into neighboring territories equipped with mobile bureau de change, bags full of dodgy money, and a roving commission to seek out gullible peasants who would swap their good money for bad. By the time it stuttered to a halt, the kipper-und-wipperzeit had undermined economies as far apart as Britain and Muscovy, and—just as in 1923 [during the infamous Weimar Republic inflation]—it was possible to tell how badly things were going from the sight of children playing in the streets with piles of worthless money

    This is an opportune moment to remind readers of a crucial distinction between inflation and rising prices. They are not the same, in spite of the commonly-held sense that they are. Inflation is an increase in the money supply (and in credit as well, though credit and capital markets in the early 1600s were small and primitive by today’s standards). Rising prices are among the many deleterious effects of the inflation.

    The German states first inflated the money supply by corrupting the coinage, then prices rose. Other effects of the inflation were evident too, including the destruction of savings and fixed incomes, a general economic malaise and social turmoil.

    In his voluminous history, The Thirty Years War: A European Tragedy, Peter H. Wilson writes:

    Good coins disappeared from circulation, while taxes were paid with debased currency. The real value of civic revenue fell by nearly 30 percent in Naumberg. Prices soared as traders demanded sackfuls of bad coins for staple commodities: the cost of a loaf of bread jumped 700 percent in Franconia beween 1619 and 1622. Those on fixed incomes suffered, like theology student Martin Botzinger whose 30 fl. annual grant became worth only three pairs of boots. Serious rioting spread from 1621, with that in Magdeburg leaving 16 dead and 200 injured.

    It was all over in about five years (the inflation, not the war). Burned by the self-defeating chaos it created, the German states agreed to stop cheating and restore reasonably sound currencies. Then through taxes, requisitions and other forms of plunder, they and most of the rest of Europe waged another 25 years of bloody hostilities.

    A hundred years later, France would be the scene of the Western world’s first experiment in hyperinflation  using paper instead of metal. And in the two centuries since that, history records dozens of ruinous paper inflations. These episodes in monetary cheating all produced the same calamitous results no matter what form they took.

    So what do men learn from history? Sometimes I think it’s little more than the fact that history is, well, interesting.

    For additional reading, see:

    “Kipper und Wipper”: Rogue Traders, Rogue Princes, Rogue Bishops, and the German Financial Meltdown of 1621-23 by Mike Dash

    Manias, Panics, and Crashes: A History of Financial Crises by Charles P. Kindleberger

    “Finance and the Thirty Years War” by C. N. Trueman

    Special Exhibit of the Deutsche Bundesbank: The German Economic Crisis of 1618-1623 

    “Where Have All the Monetary Cranks Gone?” by Lawrence W. Reed

    “The Times That Tried Men’s Economic Souls” by Lawrence W. Reed


    Lawrence W. Reed

    Lawrence W. Reed is president of the Foundation for Economic Education and author of Real Heroes: Incredible True Stories of Courage, Character, and Conviction and Excuse Me, Professor: Challenging the Myths of Progressivism. Follow on Twitter and Like on Facebook.

    This article was originally published on FEE.org. Read the original article.


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  • Monetizing the Debt Would Create Hyperinflation. Let’s Not. 

    Posted on by Azrael Comment

    There’s an invisible hyperinflation monster lurking right around the corner, which lots of people are having trouble seeing. And no, this is not a sarcastic barb aimed at conservatives who were wrong about QE and inflation — it’s aimed at people who were right, but don’t fully understand why they were right.

    Recently I’ve seen more and more people suggest that the US could simply monetize the debt, by printing money. They point to the fact that the Fed has done lots of QE, and yet inflation remains below 2 percent. So why not go all the way?

    First, let’s be clear what it means to monetize the debt. Here’s what it does not mean:

    1. It does not mean replacing interest-bearing Treasury bonds with bank deposits at the Fed, which pay an equivalent interest rate. That accomplishes nothing. You need to replace interest-bearing debt with non-interest-bearing money.

    2. It also does not mean buying back the debt only so long as interest rates are zero, but immediately selling the debt off at the slightest sign of higher interest rates, to prevent hyperinflation. That also accomplishes nothing.

    If you seriously want to monetize the debt, you’d have to buy back the debt held by the public, with newly issued base money. There are two data points that suggest this will lead to hyperinflation:

    1. Currency in circulation is about 8% of GDP.

    2. Treasury debt held by the public is about 80% of GDP.

    My claim is that if the Fed suddenly monetized the entire debt, and indicated that this action was permanent, the following would occur:

    1. In the very short run, the monetary base would balloon to 80% of GDP, mostly excess bank reserves.

    2. Within days, the excess reserves would leave the banking system, and become part of the currency in circulation. The base would now be more than 95% currency.

    3. Within a year NGDP would grow at least 10 fold, so that currency fell from 80% to no more than 8% of GDP. Indeed the increase would probably be even larger, and the currency stock would probably fall to well below 8% of GDP. That’s because during hyperinflation, velocity also tends to increase.

    4. RGDP would show relatively little change; the price level would increase at least 10 fold.

    If I am right, then why haven’t the relatively large increases in the base under QE led to large increases in the price level?

    One answer is that the Fed is paying interest on reserves, so they aren’t actually monetizing the debt. That’s true, but it’s quite possible that the QE program would have created relatively little inflation even in the absence of IOR, as we saw in America in the 1930s, and more recently in Japan and Europe.

    The better argument is that temporary currency injections are not very inflationary. By temporary, I mean for as long as interest rates stay near zero. But once rates rise above zero, banks don’t want to hold excess reserves, and all those reserves would flow out into currency in circulation. And that’s highly inflationary.

    Why do I think this would happen so rapidly? Consider the case where the market thought there was only a 3 percent chance that my theory was correct. In that case, the expected price level in 2017 would not be 1,000 percent higher, but rather a mere 30 percent higher than this year’s price level. But even 30 percent expected inflation is really high! It’s so high that banks would not want to hold onto non-interest-bearing reserves that were rapidly losing purchasing power. As the banks got rid of this “hot potato,” the price level would begin soaring, just as I predicted. In other words, there’s no stable equilibrium between 1 percent inflation and more than 1,000 percent inflation. Anything in between would imply the public is willing to hold implausibly large cash balances (as a share of GDP), despite relatively high expected inflation.

    Thus QE is only compatible with very low inflation if the public believes there is only an infinitesimal chance that the QE is permanent. Because the actual QE has not resulted in high inflation, we know that the public has a very high level of confidence that the QE is not permanent (or that if permanent, interest will be paid on the excess reserves.)

    So there really is an invisible inflation monster, lurking around the corner. The reason we never see it is because the Fed is sensible enough to not walk around the corner. They have the good sense not to print zero interest money to pay off the debt and make the money supply increase permanent. You may not see the invisible hyperinflation monster, but trust me: the monster is there. If the Fed did what some people recommend we’d see his ugly face almost immediately. And it would not be a pretty sight.

    Source: Monetizing the Debt Would Create Hyperinflation. Let’s Not. | Foundation for Economic Education


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