Quote from: bubblesort on March 23, 2013, 07:47:43 PM

From the economist who wrote half the textbooks we use in the economics department at my university:

http://krugman.blogs.nytimes.com/2011/09/07/golden-cyberfetters/

Basically, he says that bitcoin is not really being used as a medium of exchange because it's deflationary. He has a point. If you aren't using it to buy goods and services then you are using it as a way to save your money, speculating on it. Constant deflation stops people from using it as a medium of exchange.

If any currency is deflationary it makes sense to hold as much of that currency as you can for as long as you can because the value will constantly increase. This discourages spending and encourages saving. Even if every vendor in the world accepted bitcoin, people still would not spend their bitcoins if they can get around it by using USD or Euros Yen or L$ (Linden Dollars, AKA SecondLife currency) or something else.

On the other end of things, think about the effects on the credit market. Interest rates take inflation into account, to ensure that the lender makes money after inflation eats some of their investment. If a currency deflates at 5% per month then it makes sense to only loan to somebody who can make more than 5% per month on your investment (and this is compounded monthly for the life of the loan). This is because if they don't make more than that then it makes no sense to loan the money out when you can make more money by leaving it in a savings account. This would make it very difficult to buy houses and cars and start new ventures with credit.

Krugman fails to acknowledge the fact that money is a substitute for future goods and service, i.e. delayed consumption. A deflationary currency "rewards" those who can delay the consumption to a time significantly in the future. However, what ultimately determines the consumption decision is the need. In an inflationary environment you have an incentive to spend your money on things you don't really need, while in a deflationary environment you spend money preferably only on things you need.

Krugman is trapped in his keynesian assumption of the broken window economy, where spending money on useless stuff increases overall productivity.