A meme we have seen in the bitcoin community seems to be gaining traction. Bitcoin isdeflationary. That is prices of things, measured in bitcoin, are falling. For example, in spring 2011, gasoline was 1.00. This week, that same gallon had fallen to 0.0001875. Gas has gone down by 99.98 percent!
We don’t think that even the diehard bitcoin bugs really believe this.
But it leads to an interesting point. In the past, we have used the analogy of measuring a steel meter stick with stretchy rubber bands. This analogy illustrates that you cannot use something which has a variable length to measure something of constant length. We have also used the analogy of a sinking boat tossing about in the waves of as storm, where people are asking ‘why is the lighthouse going up and down, but mostly up?’ This picture helps visualize the fallacy of using the wrong perspective, the wrong vantage point, the wrong frame of reference.
We need a proper frame of reference for economic values. And now bitcoiners are (mostly jokingly) arguing that bitcoin is the correct frame. In the bitcoin frame, we are experiencing extreme deflation. Since 2011, bitcoin-CPI is -99.98.
Of course, the bitcoin bugs don’t mention the balance sheet implications of this. Suppose a business is doing perfectly fine, except that it uses bitcoin as its unit of account – callednumeraire. It made an initial investment of $1,000,000 in 2011 in factory, inventory, etc. As this businesses keeps its books in bitcoin it records this as 1,000,000 (assuming bitcoin was $1 at the time of the investment).
But by Dec 2017, bitcoin has gone up so much in dollar terms. That means that the dollar and the factory and inventory have gone down so much in bitcoin terms. Assuming no gain or loss in the investment in reality, in bitcoin terms it is now down to 62.5. This looks like near total loss! It’s not a real loss, of course, just the distortion that comes from a bad choice of numeraire.
This post was published at GoldSeek on 12 December 2017.