Won’t Bitcoin Fall in a Deflationary Spiral?

Bitcoins’ Rising Value

Bitcoins are an immensely popular peer-to-peer currency that have skyrocketed in value since their creation. Their value has increased so much that a Norwegian man who bought around $27 worth of the currency in 2009, then forgot about them, found out a mere four years later that the value of his bitcoins was nearly $900,000.

Bitcoins are now widely accepted as a currency, and through sites like Purse, you can purchase gift cards with bitcoins that can be used from everywhere from Amazon to Home Depot. This has the establishment worried. Despite their burgeoning popularity and widespread acceptance, economists continue to warn investors that Bitcoin will eventually fall into a deflationary spiral.

The Fear of Bitcoin Deflation

These economist’s reasoning is that, because there is a fixed amount of bitcoins in the world (21 million), people will eventually begin to hoard them over fears of rising prices. When people start to hoard the bitcoins, the economists say, actual spending will cease. Along with the slowing of spending, the demand for products and services will drop as well.

These economists’ concerns aren’t entirely unfounded. In countries with fiat currencies, During periods of deflation,(usually characterized by a strong currency and falling prices), spending does decrease, because people develop the rationale that they will have even more spending power in the future than they do currently. In some countries, this has led to economic problems.

Why these Fears are Unfounded

But, while this argument holds true for countries with fiat currencies, it doesn’t apply to bitcoin. This is because bitcoin is essentially just a means of transferring other currencies.

Look at it this way: at the time this article was written, a bitcoin was was worth 695 US dollars. Thus, if I was to sell you something valued at $695, and you wanted to pay me in bitcoins, it would cost you one bitcoin. If the value of bitcoins doubled, tripled, or even increased tenfold, they could still be used to complete our transaction, because you can own and spend fractions of a bitcoin. If their value rose to $6950, you could still pay me .1 bitcoin for a $695 transaction. It’s pretty simple when you break it down.

Bitcoin “Deflation” and Economists’ Fear of Savings

The fear of bitcoin’s “deflationary” nature is rooted in the idea that people who hold bitcoins won’t spend them. This idea is rooted in the fallacy that saving money is bad, while inflation is good. You don’t have to be an economist to realize how silly that sounds.

Without trying to sound like some tin-foil hat-wearing conspiracy theorist, it’s true that savings are mostly bad for banks, governments, and large corporations, who like to keep people subservient and reliant on their services. Economists who denigrate bitcoins are concerned with maintaining the status quo.

For individuals, savings are not only necessary, they are essential. Unless you relish the idea of living paycheck to paycheck, in constant fear that an emergency might come up (an expensive car repair, say), you need to save money. This has been at the core of many country’s success stories, notably Japan, who developed a strong economy with record-high savings rates.

The Stigma of Deflation

Many economists, notably Paul Krugman, think of deflation as a terrible economic sign. Historically, they’ll point out, deflation is associated with failing economies. Among many people, the word itself conjures up images of America’s Great Depression, complete with bread lines, insolvent banks, and a lack of work.

However, it is possible to have a thriving economy and falling prices at the same time. If one looks at England’s Great Depression (1873-1896), they will see that though prices fell, nearly every other economic factor (consumption of goods, production of metal and ships, as well as imports and exports) was rising.

Currently, an average citizen’s economic power is tied to their country’s economy, but options like precious metals and peer-to-peer currencies help people extricate themselves from this entanglement. This is what scares banks and economists who are more devoted to keeping the current system alive than how economically stable an individual is.

Bitcoin’s Viability as a Currency

Whether or not deflation is a bad thing for a country’s economy is entirely irrelevant to bitcoin’s power as a currency. If a fiat currency is “inflationary” and bitcoin is inherently “deflationary,” over time, people would rather have a currency that rises in value.

The powers that be will likely do anything in their power to keep bitcoins, or any other peer-to-peer currencies without regulation from a central bank, from becoming a primary currency. However, that doesn’t change the fact that they’ve increased steadily in value since their creation, which all but ensures that many people will continue to choose bitcoin over other available options.