Bitcoin + Growth = Deflation

Assume that generally MV=PY, where M is money supply, V is velocity of money, P is the price level, and Y is real GDP. Now assume that we have a bitcoin currency with a fixed money supply (M) and the velocity of money (V) is also constant. If real GDP (Y) increases, the only way for the equation to balance is for the price level (P) to decrease. That’s deflation. Every time the real GDP doubled, the prices of things would halve.

Why is this bad? Among other things, it encourages people to hoard money instead of spending or investing it. Every day you hold on to the money, it appreciates in value, at least measured in terms of purchasing power. You can probably imagine what sort of economic havoc that would wreak. Debtors would find themselves trying to pay off debts whose interest compounds even as their incomes slowly decline, in nominal terms at least. Wage stickiness and money illusion would throw people out of work or seed industrial strife.

I can’t say what will happen with bitcoin generally. You can write piece after piece about how silly it is, but ultimately it is everyday people with varying levels of sophistication that will determine what happens with it. All I can say is that I am not particularly interested in a deflationary future, and others shouldn’t be either.