Bitcoin Deflation Is Good – Yanis Varoufakis Misses The Point Again

This is going to seem like I am picking on Varoufakis but I can not help highlighting a simply massive hole in his understanding of basic economics.

He has a post on his blog here.

He is discussing the pro and cons of Bitcoin and deflation with one of his followers.

To sum it up he says this to rubbish Bitcoin and its deflation

Two reasons: First, because they can pay their taxes in it as well as a great variety of ‘stuff’ that is unavailable in bitcoins. Secondly, because if you are a producer and you need to buy raw materials (in bitcoins) at one price but then, by the time you manufacture the final product and take it to market all prices (in bitcoin) have fallen, your margin has shrunk and you wish that, instead of this deflationary currency, you bought and sold at an inflationary one. Economics 101…

So to summarise his point.

He is completely wrong for 2 reasons.

1. Price deflation over time is the same as interest payments. Either way the borrower pays back more than they borrowed. With Bitcoin charging interest is not necessary as the lender makes their money through deflation. ie they get the same amount of money back but the money can buy more products and services.

2. With deflation, even though it has “eaten” into profits in nominal terms, products and services are cheaper in the future which negates the effect of reduced profit. The deflation may mean you get 90 Bitcoins back instead of 100 but prices have gone down by the same amount which cancels out the deflationary effect on the profit margin.

Fundamentally interest on a loan and a loan made without interest in a deflationary environment is the same thing.

So why has the world gone to a system which relies on interest rather than deflation?

There is only one reason.

Government borrowing.

Governments borrowing is severely limited by a defacto gold standard such as Bitcoin.

When business borrows it expects to make more money back than it borrowed. In other words the business can service the debt and pay back the principle.

However when a government borrows it does not expect to make a profit. In other words when a government borrows and spends 100 dollars it does not do so because it expects to it receive a 110 dollars back through taxes.

Government debt is there to be serviced not to be paid back.

This servicing creates a steady revenue stream to the money centre banks that lent it the money. This revenue stream comes from the taxpayer.

To put it another way. Lending to government is a way for banks to make money from loans to the taxpayer without the taxpayer choosing to take out that loan.

The debt is forced upon the populus through the government’s monopoly on the use of violence and the population is then forced to pay interest on this involuntary debt in the form of taxes.

Getting back to why we live in an inflationary world.

Lending to government would simply not work in an economy where there was deflation.

If the government did not pay back the principle the debt would rapidly get out of control.

It would get out of control because tax revenues would be decreasing in real terms due to the cost of products and services decreasing along with wages.

In this environment lenders to government would only make money when the government was reducing its debt.

So given this situation, no institution is going to lend money to the government in the first place.

Okay, but why do institutions want to lend money to a government?

There are 3 very simple reasons.

1. Profitable. Governments are by far the single biggest borrowers of money on the planet.

2. Easy. You only have to deal with one entity to make the loan which is much easier than making thousands of different loans to individual business.

3. The use of force. Governments are unique in their ability to “legitimately” force you to pay them with the use of physical violence. Governments are less likely to default. A government can simply increase the amount of the monthly repayments by increasing taxes and force people to pay.

But again Yanis Varoufakis misses all these very obvious points as to why a stable currency and a deflationary economic environment is a good thing and to reinforce his position he decides to insult the person who is trying to explain to him  the simple facts.

It is clear that we are inhabiting different universes. Yours is one in which Keynes was inimical to… saving. One in which savings happens when one holds an appreciating currency. One in which iPhones cost less with every year that passes. One in which you cannot distinguish deflation from prices reductions due to increasing returns and falling average costs of production. Etc. etc. In this weird universe of yours, bitcoins may seem a splendid alternative currency. Alas, permit me to say, yours is a fictitious universe utterly disconnected from the one we (including your good self) live in.

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