[felixreyes]

Hello Professor Jeff Herbener,

Can you please share your thoughts on deflationary currencies? In lesson one you mentioned that the larger the stock of a currency, the lower the purchasing power of that currency.

Apparently, Bitcoin has a lifetime limited supply of 21 million coins. Based on similar events in the past throughout history, did currencies with limited supplies become more valuable when the supply ended? It’s hard to compare this currency with precious metals, because the supply of assets like Gold seems to be limited, but the exact information related to the potential supply amount of Gold is unknown.

Thank You.
Felix

[jmherbener]

Coinage has a long history during which there has been a general increase in the stock of coins from production. This has been true for the precious metals most often used as money: gold, silver, and copper. As you say, we have no historical cases of a metal with a strictly limited potential that has been used as money. As a consequence, we must rely solely on theoretical analysis to determine the impact of Bitcoin’s limited stock on its suitability as money.

What we know from theory is that during economic progress the demand to hold money increases which tends to increase the purchasing power of money (i.e., tends to result in price deflation). Since the rise in its purchasing power makes the production of money more profitable, entrepreneurs will devote more resources to production. The resulting increase stock of money tends to to decrease the purchasing power of money. In this way, the market economy results in the efficient production of money in the same manner as that of other goods. Whether, on balance, the purchasing power of money increases (price deflation) or decreases (price inflation) the efficiency of the market economy is unaffected except in one special case. Suppose that the rate of price deflation (say 10%) is greater than the time-preference rate of interest (say 4%). Then money lent today would earn a 4% gain in purchasing power with a -6% rate of interest. But nobody would lend say $1,000 today to get back $940 a year from today. Instead he would simply hold onto the $1,000 and have $1,000 in a year. Whether or not Bitcoin, if it became money, would suffer from this problem is an empirical question that, as you say, we have no evidence to help us resolve. What we do know theoretically, however, is that in a free market entrepreneurs would adopt something else as money if such a problem arose with their current choice of the thing used as money.

Here’s an estimate of the world’s production of gold and Silver over time:

https://ourworldindata.org/grapher/gold-production

https://www.moneymetals.com/news/2017/12/18/world-silver-production-charts-001321

[jmherbener]

Coinage has a long history during which there has been a general increase in the stock of coins from production. This has been true for the precious metals most often used as money: gold, silver, and copper. As you say, we have no historical cases of a metal with a strictly limited potential that has been used as money. As a consequence, we must rely solely on theoretical analysis to determine the impact of Bitcoin’s limited stock on its suitability as money.

What we know from theory is that during economic progress the demand to hold money increases which tends to increase the purchasing power of money (i.e., tends to result in price deflation). Since the rise in its purchasing power makes the production of money more profitable, entrepreneurs will devote more resources to production. The resulting increase stock of money tends to to decrease the purchasing power of money. In this way, the market economy results in the efficient production of money in the same manner as that of other goods. Whether, on balance, the purchasing power of money increases (price deflation) or decreases (price inflation) the efficiency of the market economy is unaffected except in one special case. Suppose that the rate of price deflation (say 10%) is greater than the time-preference rate of interest (say 4%). Then money lent today would earn a 4% gain in purchasing power with a -6% rate of interest. But nobody would lend say $1,000 today to get back $940 a year from today. Instead he would simply hold onto the $1,000 and have $1,000 in a year. Whether or not Bitcoin, if it became money, would suffer from this problem is an empirical question that, as you say, we have no evidence to help us resolve. What we do know theoretically, however, is that in a free market entrepreneurs would adopt something else as money if such a problem arose with their current choice of the thing used as money.

Here’s an estimate of the world’s production of gold and Silver over time:

https://ourworldindata.org/grapher/gold-production

https://www.moneymetals.com/news/2017/12/18/world-silver-production-charts-001321

[jmherbener]

Coinage has a long history during which there has been a general increase in the stock of coins from production. This has been true for the precious metals most often used as money: gold, silver, and copper. As you say, we have no historical cases of a metal with a strictly limited potential that has been used as money. As a consequence, we must rely solely on theoretical analysis to determine the impact of Bitcoin’s limited stock on its suitability as money.

What we know from theory is that during economic progress the demand to hold money increases which tends to increase the purchasing power of money (i.e., tends to result in price deflation). Since the rise in its purchasing power makes the production of money more profitable, entrepreneurs will devote more resources to production. The resulting increase stock of money tends to to decrease the purchasing power of money. In this way, the market economy results in the efficient production of money in the same manner as that of other goods. Whether, on balance, the purchasing power of money increases (price deflation) or decreases (price inflation) the efficiency of the market economy is unaffected except in one special case. Suppose that the rate of price deflation (say 10%) is greater than the time-preference rate of interest (say 4%). Then money lent today would earn a 4% gain in purchasing power with a -6% rate of interest. But nobody would lend say $1,000 today to get back $940 a year from today. Instead he would simply hold onto the $1,000 and have $1,000 in a year. Whether or not Bitcoin, if it became money, would suffer from this problem is an empirical question that, as you say, we have no evidence to help us resolve. What we do know theoretically, however, is that in a free market entrepreneurs would adopt something else as money if such a problem arose with their current choice of the thing used as money.

Here’s an estimate of the world’s production of gold and Silver over time:

https://ourworldindata.org/grapher/gold-production

https://www.moneymetals.com/news/2017/12/18/world-silver-production-charts-001321

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