el_senor_duerpo

I'm always peeved by this reference to Keynes. This is a topic that is universally recognized by almost all economists, with the exception of a few Austrians. In fact, the main proponent of this concept was a conservative economist from the University of Chicago named Irving Fischer. Because the Great Depression was a period of absolute deflation (falling prices and falling output), this was a central concern to Keynes as well. However, it was none other than Milton Friedman, a lead figure in the resurgence of neo-liberal (libertarian) thought in the mid 20th century. In fact, Milton Friedman's most famous work (the work with Anna Schwartz), was all about how the Fed caused the double-dip in the Great depression by enforcing the gold standard and contracting the money supply. See? Friedman (a libertarian) rose to fame for his claim that the Fed destroyed too much money during the Great Depression!

Edit: One quick thing I forgot. Keynesian economics is all about the idea that, if prices are "sticky" and cannot fully adjust in real time, then that leads to drops in output. The flip side of this, which is evident in the current crisis, is downward nominal wage rigidity. The fact that prices are slow to adjust partially mitigates the threats of deflation. So if anything, Keynesians have less to worry about from deflation than other factions of macroeconomists.

I'm pretty sure I explained the value of use of bitcoins as a medium of exchange in footnote 2. The convenience and ability to facilitate transactions on the black/grey market might cause bitcoins to trade at a slight premium. On the other hand, volatility, concerns over hacking, exchange lag, and the threat of future government regulation may overshadow this and cause them to trade at a slight discount. I split the difference and assume that prices in the bitcoin economy adjust relative to the spot price, so that the real exchange rate is one-to-one. The problem isn't with the utility of a crypo currency in the abstract. It's that this will never come to fruition with built-in flaws like deflation, which inevitably lead to bubbles.

Ha, um no... That would be nice.

First of all, if our actual markets started to experience this kind of volatility, circuit breakers would kick in.

Second, even if they didn't the Fed could easily respond in real time. It's not as if the Fed actually, literally "prints money". They would just go onto those forex markets and sell people dollars, transferred digitally and made up out of thin air. And their servers wouldn't crash while doing it.

Edit: I should add to this that, at least to a first approximation, the Fed is not terribly concerned with the nominal exchange rate. They are charged with maintaining full employment and price stability within our own economy, while the nominal exchange rate is allowed to float against other currencies. Because have have our own production economy, there are good fundamental reasons for fluctuations in the real exchange rate that should be permitted to occur.

No, production is not exclusive to manufacturing. It means valued-added. For example, if you bought a dvd from amazon using bitcoin (I have no idea if this is possible), then very little of what you paid would count in bitcoin GDP. All of the costs of production (warehouses, delivery, labor, servers, etc.) are done in the US economy using dollars, so that basically doesn't register as bitcoin GDP.

On the other hand, let's suppose someone is buying a bag of... something. Well, everything that got that bag to the dealer was done in some other production economy. So the only value added, that would count as a service in bitcoin GDP, would be the dealer's profits, measured in bitcoins.

To my knowledge, there are no investment projects being financed in bitcoins. If there were, then they probably just defaulted on their loans, which increased tremendously under deflation. Therefore, it's best to think of the bitcoin economy almost entirely as pure exchange, with very little value added and very little wealth created.

As for fiat currencies, why is everyone so interested in the nominal exchange rate anyway? This was a peculiarity that I noticed a while ago. In college, I went on a study abroad program to Mexico. When we arrived, we all exchanged our dollars for pesos. Everyone was carrying on about how strong the dollar was, because one dollar could buy ten pesos. But then I noticed something. I went to McDonalds, and instead of a "dollar menu", they had a "10 peso menu". Who cares how many pesos you get for a dollar? It's about how much you can buy with that dollar worth of pesos, and that's measured by the real exchange rate. I realized at that moment that purchasing power was much closer to parity than most people think, because they put so much weight on nominal rates.

Exactly, that's a huge mistake. Shifts in demand cause shifts in supply? That's not obvious at all. The whole point is that supply and demand have different determinants, but they mutually determine quantities and prices.

Sure, lots of the stock market is arbitrage. While bubbles form in different markets, they are all eventually followed by a correction. The problem with bitcoin is that there is no fundamental asset underlying the currency. So when there's a correction, there's no sense of where the bottom is.

I am an economist, and I have no idea what that means. Sounds to me like confusion over two things: (i) the difference between "supply and demand" and the "quantity supplied" or "quantity demanded" and (ii) equilibrium. The circular logic is a tell tale sign. Price goes up, so people demand less, so price goes down, so people demand more... That's the whole point of equilibrium. Where does all of that net out.

Two quick remarks. First, there already are many virtual/digital currencies, some of which simply peg their currencies to the dollar. But nobody really cares. Why? Well, what's the point? It's just a slightly less convenient form of a dollar.

Second, we all already do use digital currency. Actual, physical currency (and deposits at the Fed) are called the monetary base or "high powered money". However, most people transact goods using debit cards, which is called "inside money". These are privately created dollars, and they change hands digitally. So, we're already there. (I'm avoiding credit cards since those are technically loans, not money).

Here's the problem. You're talking about traders, but where is the capital? You can't have a financial market purely based on currency speculation. If we're going to talk about bitcoins as though it were an asset (store of value), rather than a money supple (unit of account or medium of exchange), then we need to verify which properties of an asset it possesses.

Do bitcoins provide a consumption utility stream? Do they yield dividends. What sorts of productive risk-taking do they represent? When I buy a stock, it will perform well if the risks it takes in providing mutually beneficial exchange with business and households are successful. For bitcoins, there is no systematic market risk, because there is no capital stock. Why? The same reason as always. Deflation increases the burden of debt which decreases investment, even though the economy is awash in savings.

Our national economies do not possess cycles as you describe them. Here's a good article about macroeconomic business cycles: http://noahpinionblog.blogspot.com/2013/02/is-business-cycle.... While the level of inflation fluctuates in our economy, it does so on a much smaller scale: http://en.wikipedia.org/wiki/File:US_Historical_Inflation_An.... What really jumps out from that graph is how the best economic prosperity the world has ever seen coincides with fiat currency ending the threat of deflation.

Well, here's Mt. Gox today: http://bitcoinity.org/markets/mtgox/USD

And here's what happened on another exchange while Mt. Gox was down: http://bitcoinity.org/markets/btce/USD

This is exactly right. The problem is in some respects worse than stated. After the last bubble, it appears as though speculators did leave. However, every time the demand increases sharply for bitcoins, they return. After all, who could resist such a fantastic arbitrage opportunity?

I think it does describe what happens in the long term. Basically, if the thing can never get off the ground in the short term, then it will never get off the ground in the long term. Every surge in popularity has the high likelihood of setting off a speculative bubble. As the rate of increase in the stock of bitcoins decelerates, this problem will only get worse.

Would you prefer I write in in LaTex and using fancy graphs from Matlab, R, or Matplotlib? Or are you just being mean?

Hi there. Actually, I did cover value of Bitcoin in use as a medium of exchange in footnote 2. Because there is no production in the bitcoin economy, or very little to be entirely accurate, the real exchange rate should basically be one. Why? Because most users of bitcoin live within very large production economies. Why would buyers pay more or sellers accept less, if they would be better of transacting in the domestic economy?

You might imagine a slight premium for bitcoins because they facilitate transactions that would be difficult in the domestic economies, such as money laundering or black market trade, but you could just as easily argue that the real exchange rate is less than one due to the relatively lower number of people to trade with, concerns regarding being hacked, and uncertainty regarding future government regulation of bitcoin. That's why I decided the most neutral approach would be to assume purchasing power parity across bitcoins. Admittedly, this assumption may not be great as speculation runs rampant and everyone runs for the exits, which would imply a heavy discount in the real exchange rate.