Quote from: jtimon on September 13, 2011, 02:47:08 PM

Quote from: steelhouse on September 13, 2011, 09:44:04 AM

Deflation has no effect on an economy and if anything it is generally good because it helps the savers retain value of their savings.

Please, read my previous example and tell me where I'm wrong.
Deflation discourages investment (real capital accumulation) and that is definitely bad for the economy.
Of course, my example assumes an economy with just one currency, which will never be the case for bitcoin. I don't think deflation will destroy bitcoin, but I don't like the deflation is innocuous/good dogma shared by many people here.
As someone pointed out in a thread called "about hoarding", deflation makes bitcoin less suitable for commerce. Having alternative mediums of exchange, it will make the currency drop in value, which will eliminate the deflation. Deflation will not destroy bitcoin, but it will prevent it from having a healthy financial market.
Remember that lending you're also saving. There's no need for hoarding to save.
And please don't answer me with the flaws of inflation because I don't advocate for it and I'm with Hayek in the fight of the century. Just in case, I'm not keynesian!!!

"So if the lender knows the inflation rate, he should (and will if he can) ask the real interest rate plus the inflation rate.
With deflation, he's not going to ask the the real interest rate less the deflation rate, he will get at least the lower of the two. If real capital yields go below the deflation rate, no lending at all would happen. Nothing. Lenders would just prefer to keep earning from deflation rather than investing in any real capital, even if it is profitable in real terms.
In this case there's no real investment out there that outperforms hoarding, so rational investors should not lend.
But when the deflation rate is lower than the capital yields, the problem is still there:
Some business that are profitable in real terms will turn out to be insolvent in a deflationary scenario, because financial costs are in nominal terms and your income and collateral are being devalued nominally."

2. I still think deflation makes borrowing to invest less desirable.
Say we have a potential secure investment that yields 5% of its value annually and interest rates are at 5%.
Our baker starts his bakery (and discounting its own wage and other costs) profits a 5% of the investment that goes to pay interest. After twenty years, the baker sells his bakery at the same price and pays back the full loan.
With stable prices, the investment covers its financial costs and therefore is economically viable.
With deflation, you also have to cover the gains of money from deflation to get the loan.
Say we have 5% annual deflation.
That same investment won't get the loan.
Producing exactly the same and selling the products at lower price each day, the baker can lower his wage to compensate deflation and will buy its supplies at a lower price, but he cannot lower the interest. Even if the loan is made in a way that the monthly payment of interest for the whole period takes deflation into account, the borrower will not be able to pay the loan after that period.
We have assumed a constant revenue of 5% and assuming there's no changes in the competition, there's no reason to expect it to go down.
But the nominal revenue has decreased. What has happened is that the capital (the bakery) has devalued. In our case to 0.95^20 = 0.358485922 % of its original price.

The business should have grown at a 5% rate too to compensate deflation. The interest paid monthly could be nominally constant in this case. Only the very best investments will get funded with deflation.

Where you are wrong: You don't consider hoarding and savings as an investment too.

So say you have an economy with 3% deflation? Do you still want to buy things? As long as you want to buy things there is an economy! So someone has an idea they can either offer an interest rate above the 3% deflation or find shareholders. A 1% loan is really a 4% return, 1% for the loan and 3% for the deflation. The reality is there would be no debt anywhere in the economy, which is good for the economy.

Many businesses hold debt, not because they need the money, but they want to hedge against inflation. They can deduct the interest from taxes. Thus rather than repay debt, they extend their debt so they don't have to maintain as much cash.

2. Where do you think money will be optimally invested by a banker giving loans to business or by a stockholder buying equity in a firm?

Since 1802, the stock market has returned $600,000 after inflation for every dollar invested. Bonds have returned about $1000. However, cash in a bank account has return nothing and is presently earning negative. Yes, there would be far less loans, but the businesses don't deserve them and bankers don't deserve to receive the interest off them. They earn money by using other peoples money at low interest and making loans at higher rates to earn a spread. I don't have the numbers but if you do the math it will show as a disaster to people who put deposits in banks. It would be much better to have a deflationary currency it allows savers to earn yield on their savings without using banks. Thus, when the 85 year old senior citizen wakes up one day they won't see their money gone, stolen by the ravages of inflation.