Author: Dai Xinsheng Source: Airdrop Reference

On March 24, Strategy (formerly MicroStrategy) made another big move - buying 6,911 bitcoins at an average price of US$84,000, and its total Bitcoin holdings officially exceeded the 500,000 mark, with an average cost of US$66,000. Based on the current price of about $88,000, the company has made a floating profit of $22,000 per Bitcoin.

It is not difficult to see that no matter which time node you stand at, looking at the global wave of cryptocurrencies, Bitcoin is always the most shining existence. But since its birth in 2009, it has never escaped controversy. Especially in the economics community, doubts about Bitcoin have always been heard. One of the most cited criticisms comes from Nobel Prize winner in Economics Paul Krugman.

Krugman once pointed out sharply that if an economic system is based on Bitcoin, due to its constant total supply, it will inevitably lead to rigidity in the money supply, which will lead to deflation. He warned that this "deflation trap" will induce people to delay consumption, decline in corporate profits, and a surge in layoffs, which will eventually lead to the economy entering a vicious cycle of recession. I have also made an in-depth analysis of this view in "Bitcoin Should Be a Mirror for Us".

Now, the "deflation trap" has become one of the common reasons for boycotting Bitcoin. But the question is, is this statement really valid? Deflation is really a fate that Bitcoin cannot overcome? Or is this just a misunderstanding of new things by the traditional paradigm?

To answer this question, we must first figure out:

What is deflation?

How does deflation occur?

Only by deeply understanding these two issues can we truly judge whether it is an old enemy or a misunderstood relationship between Bitcoin and deflation.

About bitWe have talked a lot about coins; and you may still feel a little unfamiliar with "deflation". Fortunately, the book "Bitcoin Standard" can make up for this lesson for us.

1. What is deflation?

Deflation is the abbreviation of deflation. To put it simply, currency is actually what we often call money. Deflation means that money in the market has become less.

To deeply understand deflation, we must first start with its opposite, inflation, and when talking about inflation, we have to first talk about the concept of "money supply". Only by understanding the connotation of the money supply can we truly understand the internal logic of inflation and deflation.

The money supply is usually expressed in "M", and it is divided into multiple levels according to the strength of the money liquidity. Among them, M1 and M2 are the most commonly used.

M1 is called "narrow currency". It contains cash (banks and coins) and current deposits. These funds can be consumed at any time and are extremely liquid. For example, the banknotes in your wallet and the electronic payment balance on your mobile phone all fall into the category of M1.

M2 is called "broad currency". It not only includes M1, but also assets such as fixed deposits, savings accounts and money market funds that are relatively difficult to cash out immediately. Although this money cannot be consumed anytime and anywhere, it usually only takes a certain amount of time or a small amount of interest loss to be converted into liquid cash.

The key to the occurrence of inflation or deflation is the relationship between the money supply indicators, M1 and M2, and the supply of goods and services.

When the money supply (such as M2) grows beyond the growth rate of the supply of goods and services, too much money will chase relatively limited goods and services, driving prices to rise generally, which is "inflation". According to the Federal Reserve data, the United States implemented large-scale monetary easing after the epidemic in 2020, and the supply of M2 increased by an astonishing 24% throughout 2020, see the figure below. This currency flood directly led to the US inflation rate reaching 7% in 2021, a record high in nearly 40 years, and consumers clearly felt the rapid rise in daily necessities, food and energy prices.

and deflation, then the opposite is true. When the money supply growth rate is lower than the supply speed of goods and services, and even the money supply is absolutely reduced, money in the market is becoming increasingly "scarce". Naturally, more and more things can be bought in the same amount of money, and prices will generally fall - this is "deflation".

The most classic deflationary case in history was the Great Depression in the United States in 1929. At that time, banks went bankrupt in large numbers, and both M1 and M2 contracted sharply. The sharp reduction of this currency directly led to the depletion of market liquidity, the sharp decline in prices, the rapid shrinking of corporate profits, and large-scale layoffs broke out, and the entire economy fell into a negative spiral. What happened to the Great Depression? How does deflation happen? This will be discussed in detail later.

In contrast, inflation is like a "fever", with too much money and the economy "has a fever", which can easily lead to speculative bubbles and wealth shrinkage; while deflation is like a "cold disease", with less money and the economy falling into freezing, people are unwilling to consume, companies dare not invest, and economic activities are gradually stagnant.

Next, let's take a look at the Great Depression that happened in the 1930s because it was caused by deflation.

2. The Great Depression, a terrible deflation?

Whenever deflation is mentioned, people usually think of the cold winter of the recession, as if the entire society is in a state of freezing.

The most direct association is often this black and white photo of the Great Depression in the 1930s: In February 1931, during the Great Depression, there were long queues of unemployed workers outside a soup kitchen opened in Chicago.

During that period, the United States experienced drastic deflation, and prices fell like kites with broken strings. According to historical data, the Consumer Price Index (CPI) in the United States fell by about 25% from 1929 to 1933. This means that if you had $100 in 1929, by 1933, that $100 had the purchasing power equivalent to about $133 today. It may sound like a good thing, but it is far from it.

Why is this happening?

Because deflation does not only mean that commodity prices fall, it will also freeze the entire economic cycle. Imagine aNext, when people are expecting prices to be cheaper tomorrow, no one is willing to spend today. In 1929, U.S. retail sales shrank sharply from $48.4 billion to $25.1 billion in 1933, almost halved. The sharp drop in consumption has caused a large backlog of inventory for enterprises, and profits plummeted, and large-scale layoffs have to be made. This further hit consumer confidence, with unemployment rising all the way from 3.2% in 1929 to a stunning 24.9% in 1933, pushing a quarter of the labor force to the streets. The economy is like falling into a bottomless vortex, struggling but getting deeper and deeper.

But, I tell you now that deflation is not only a terrible side, but also a cute side. Do you feel strange?

3. Great prosperity, lovely deflation?

People usually closely link deflation with depression, but history tells us that deflation does not necessarily lead to economic recession, and sometimes it can even be accompanied by unprecedented prosperity. The most typical example is the golden standard period known as the "Belle Époque" in the late 19th century.

In fact, similar phenomena have occurred in human history before the better times. For example, Renaissance Florence and Venice, two cities, rapidly rising to become centers of Europe's economy, art and culture, thanks in large part to their first adoption of robust and reliable monetary standards.

3.1 Gold Coins and Renaissance

In 1252, Florence issued the famous Florin gold coins. The emergence of Florin gold coins is of great significance. It is the first time that Europe has once again owned a gold currency with extremely high purity and reliable quality since the "Aureus" during the period of Caesar in ancient times. Each Florin gold coin weighed about 3.5 grams and had a pure gold content of 24 carats. Its stable color and fixed weight made it quickly become the standard currency for European trade at that time.

The reliability and stability of Florence's gold coins have quickly improved Florence's position in the European economy and also driven the booming development of the banking industry. The Florentine bankers at that time, such as the famous Medici family, laid the foundation for the modern banking system through branches throughout Europe, providing deposits, loans, exchanges, currency exchanges and other services. With the support of Florin gold coins, merchants across Europe were able to conduct cross-border trade with confidence and no longer worry about the losses caused by currency depreciation and exchange rate fluctuations.

Subsequently, in 1270, Venice also followed Lorenze's Ducat gold coins, which was exactly the same as the specifications and quality of the Florin gold coins, allowing this reliable currency standard to spread rapidly throughout the European continent. By the end of the 14th century, more than 150 and regions in Europe had issued gold coins similar to Florin specifications. The unity and reliability of this currency greatly simplified the international trade process and accelerated the flow of capital and wealth accumulation within Europe.

Of course, what best represents deflation prosperity is still The beautiful years of the late 19th century. During this period, deflation and economic prosperity were wonderfully combined, creating an unparalleled golden age in human history.

3.2 The deflation and prosperity of the beautiful era

The beautiful era

The strong monetary system established by gold coins not only gave birth to the glory of Florence and Venice during the Renaissance, but also achieved the perfect integration of economic prosperity and technological innovation in the second half of the 19th century.

left;">At this time, the world mainly adopted a unified gold standard, and the exchange between currencies became extremely simple. Different currencies are essentially gold of different weights. For example, the British pound was defined as 7.3 grams of gold, the French franc was 0.29 grams, and the German mark was 0.36 grams, and the exchange rate was naturally fixed. For example, 1 pound could always be exchanged for 26.28 francs and 24.02 German marks. This simple and direct exchange mechanism enabled global trade.As simple and clear as measuring length, it truly realizes the vision of global free trade.

Under this gold standard system, without the currency interference of the central bank, how much currency people hold depends entirely on their needs, rather than being manipulated by the central bank. The reliability of money encourages people to save and accumulate capital, and promotes rapid progress in industrialization, urbanization and technology.

In this stable monetary environment, social productivity has made rapid progress. A large number of major innovations and inventions that changed the world's appearance emerged in the better years: in 1876 Bell invented the telephone; in 1885 Carl Benz developed the first internal combustion engine car; in 1903, the Wright brothers achieved the first human power flight; in 1870, the total length of the American railway was about 50,000 miles, and by 1900, it had expanded to 1999. Ten thousand miles, completely changing people's lives and business models.

The medical field is even more shocking. Medical breakthroughs such as cardiac surgery, organ transplantation, X-ray, modern anesthesia, vitamins, and blood transfusion technology were born in this period. These innovations not only improve productivity, but also greatly improve the quality of life and life span of human beings. The rise of petrochemical technology has given birth to key materials such as plastics, nitrogen fertilizers and stainless steel, greatly improving agricultural and industrial production efficiency, and making a large number of commodities cheaper and easier to obtain.

As economist Ludwig von Mises said, "The quantity of money is not important, what matters is its purchasing power. What people need is not more money, but more purchasing power."

The prosperity of the cultural and artistic fields is also inseparable from the support of a prudent monetary system. Just like Florence and Venice in the Renaissance, a large number of art masters emerged in central European cities such as Paris and Vienna in the better times. These artists and thinkers benefit from low time preferenceInvestors, who patiently funded artistic creation, promoted the prosperity of neoclassical, romantic, realist and impressionist art.

The reason why the beautiful era is so nostalgic in history is not only because it achieved unprecedented economic growth, but also because it wonderfully combines deflation with economic prosperity. The continued decline in prices has not caused consumption stagnation, but has allowed people to enjoy a higher quality life with less money.

Facts show that deflation does not necessarily lead to an economic recession. Then, you may want to ask:

So why did the deflation that began in 1929 cause the Great Depression again?

Why does the same deflation have different results?

If deflation has no "sin", then who has "sin"?

Only by deeply understanding the ins and outs of the Great Depression can we dig out the real cause and answer the above questions.

4. How did the Great Depression form step by step?

When you go back to the 1920s, you will find that it is a world full of gold. The Great Depression happened in this context. All this stems from the Fed's extremely loose currency in the early 1920s.

To help Britain stabilize the pound and prevent British gold outflows, the Federal Reserve lowered the discount rate from 4% to 3% between 1924 and 1928. Although it only seemed to have dropped by 1 percentage point on the surface, this greatly stimulated the demand for funds in the market, as if it had opened the floodgates of funds, and the US dollar poured into the economy like a flood.

In this extremely loose environment, investors find that loans have become extremely cheap, as if there are free lunches everywhere. According to the Bitcoin Standard, the US money supply increased by an astonishing 68.1% between 1921 and 1929, far exceeding the growth of gold stock by only 15%.

As a result, a large amount of cheap funds poured into the stock market, and the Dow Jones Index rose wildly from 63 points in 1921 to 381 points in September 1929, up more than 500% in eight years. The market craze has comeIt is incredible that even ordinary workers, taxi drivers, and housewives are borrowing loans to trade stocks.

Economist Irving Fisher confidently claimed on October 16, 1929 that the stock market had reached a "permanent plateau" and believed that high stock prices would not fall again. However, just one week later, on October 24, 1929, the US stock market began to plummet and the bubble completely burst. In fact, as early as the end of 1928, the Federal Reserve had already noticed the risk of asset bubbles and began to tighten currencies, raise interest rates, and try to ease the overheated economy. However, the sudden turn of the Federal Reserve shocked the market: high interest rates broke the illusion of continued rising asset prices and the bubble burst quickly. On October 24, 1929, "Black Thursday" marked the beginning of a major stock market crash.

After the stock market bubble burst, all cheap loans became a heavy burden, bank loans could not be recovered, and cash flows quickly dried up, triggering a large-scale run.

At this time, the Fed should have actively provided liquidity to the banking system to avoid further panic, but the Fed adopted a relatively negative attitude. Allowing banks to go bankrupt further deteriorated public confidence, with the total bank deposits reduced by about one-third, and the M2 money supply plummeted by more than 30%. From 1929 to 1933, about 10,000 banks in the United States went bankrupt.

Of course, the United States' mistakes have further aggravated the situation. At that time President Hoover and his successor Roosevelt implemented a series of interventionisms, including fixed wages and setting price controls, in an attempt to "freeze" the economy at a prosperous level. For example, in order to maintain agricultural product prices, the United States has taken absurd measures to incinerate crops, which is particularly ridiculous in the context of economic depression and hunger.

Seeing this, you should understand:

The deflation of the Great Depression was not a natural form in the better years, but a result of the Federal Reserve's improper manipulation.

Economist Milton Friedman believes that if the Fed rapidly increased its money supply at that time, the bank failure and runs could be alleviated, thus avoiding the subsequent long-term economic recession.

However, the author of the book "Bitcoin Standard" points out that Friedman ignored the root cause of the problem: the economy was already severely distorted by artificial currency expansion in the 1920s. After the stock market bubble burst, simply injecting more money into the market will not really solve the serious mismatch in the economic structure, but will only make the future crisis more severe.

In other words, if not When the currency expansion began in 1921, there would be no sudden sudden currency contraction, and it would be impossible for the Great Depression to occur for the 10-year period.

So, why did the United States engage in currency expansion for the United Kingdom in 1921? Is the United States really doing good things?

5. Was the Great Depression caused by the United States' helping others?

The extremely loose currency adopted by the Federal Reserve in the early 1920s was ostensibly to help the Bank of England prevent gold outflows and maintain the pound exchange rate, but this was not just for the simple "helping others". In fact, the United States itself also has clear interest considerations.

After the war, Britain was eager to revive London's position as a global financial center. In 1925, British Chancellor Winston Churchill announced a return to the gold standard, returning the exchange rate between the pound and gold to pre-war highs, £4.86 per ounce of gold. This seemingly wise decision has laid serious risks for the British economy.

Why? Because after the war, Britain's production capacity and economic strength have declined significantly, and the pound has actually no longer had pre-war purchasing power. If the pre-war overvalued pound exchange rate is forced to resume, the price of British commodities will become extremely uncompetitive and Britain's exports will face a huge impact. A large amount of gold will quickly flow out from Britain to the stronger economic United States.

In fact, this did happen. Britain's gold reserves fell rapidly after the gold standard was restored, and the situation was extremely serious. If it continues, Britain may have to give up the gold standard again and further hit the international credit of the pound. This is something the UK will never want to see.

But why is the United States willing to help Britain? Is the United States just doing good things simply?

This is not the case.

5.2 The United States, which has "dead lips and teeth," at the time, the Federal Reserve and Wall Street elites had clear strategic goals. They hoped to take this opportunity to gradually replace London as a global financial center. In other words, Wall Street was willing to temporarily maintain UK financial stability through loose currencies, in the hope of avoiding the rapid collapse of the UK due to gold outflows.

Why? Because if the British economy suddenly collapses, the entire European financial system may collapse. This is not a good thing for the United States. The United States provided a large amount of loans to Europe during World War I, and the stable economic environment in Europe is crucial to the United States. The stability of British finance will create a more favorable investment environment for the United States in the European market.

Simply put, American financiers did not want to see the British financial market collapse prematurely because it would affect their huge interests in the UK.

5.3 "That's against our wishes" rate cut

In this way, for the sake of the United Kingdom and for themselves, the Federal Reserve adopted a series of easing between 1924 and 1928, lowering the discount rate from 4% to 3%. On the surface, it seems that it is just a slight interest rate cut, but in fact it is equivalent to opening up the flood gate of funds and a large number of dollars pouring into the market. American banks quickly lend out these cheap funds to stimulate economicThe illusion of prosperity in the 1920s was pushed up asset prices.

This strategy does work in the short term. The UK's gold outflow has been temporarily alleviated, the pound has temporarily stabilized, and the collapse of London's financial market has been postponed. But the problem is that this artificial intervention has lowered US market interest rates and caused serious economic distortions.

Specifically, too low interest rates encourage companies and individuals to invest blindly, stimulating the speculation boom in real estate and stock markets. From 1921 to 1929, the Dow Jones Index rose by more than 500%, and real estate prices soared, eventually forming a huge asset bubble. From a larger historical perspective, the Federal Reserve's this kind of strategic arrangement is not only not purely helping others, but an American elite seeking their own financial dominance by helping the United Kingdom. Although the US economic interests and asset security in Europe were protected in the short term, it ultimately laid greater hidden dangers for the US economy.

Facts have proved that this short-sightedness ultimately backfires. When the bubble burst in 1929, the Federal Reserve and the United States not only failed to avoid the crisis, but instead led to an unprecedented recession in the US economy. This Great Depression was caused by the previous artificial manipulation of money supply and interest rates.

The author of "Bitcoin Standard" pointed out that it was the Fed's actions in the 1920s that led to subsequent economic catastrophic consequences.

Now, we can finally see clearly:

Deflation itself is not terrible, what is terrible is the arbitrary manipulation of currency and interest rates by the central bank.

Back to the beginning, it should be clear whether the fixed currency supply represented by Bitcoin will cause a "deflation trap".

6. Is the deflation trap just a "man-made disaster"?

The reason why currency can be widely accepted and used is because it has a stable value scale. This stability, like a precise ruler, allows people to calculate costs, benefits and future returns with confidence in complex economic activities.

But the problem is precisely the value ruler of traditional legal currencyThe degree is not stable, and it may fluctuate violently due to the central bank at any time. The painful lessons of the Great Depression of 1929 prove this: artificial manipulation of money supply and interest rates undermines the basis of currency as a stable measure of value. This kind of artificial deflation is the real disaster. On the contrary, if deflation is a natural decline in prices due to improved production efficiency and technological progress, such deflation is not destructive, but has great positive significance. The "better age" and the Renaissance in history are the best examples of the brilliant achievements brought by this "natural deflation".

We have already said that we might as well review the industrial revolution at the end of the 19th century when it was in a deflationary period:

From 1870 to 1900, the US Consumer Price Index (CPI) fell by about 30%, which means that prices fell by about 1% per year on average.

steel output soared from 20,000 tons in 1865 to 10 million tons in 1900;

manufacturing output value increased by more than 500%.

This shows that the gradual decline in prices is actually a manifestation of economic prosperity, not a precursor to economic stagnation.

Given another example that is closer to the modern era: From 1980 to 2000, the US technology industry flourished, with computer prices falling by nearly 90%, but functions increased thousands of times. Similarly, the price of smartphones is also declining, but their functions are changing with each passing day. Consumers did not stop buying because they "expected computers to be cheaper next year." Instead, they continued to buy better devices because demand itself was not unlimitedly delayed.

In fact, this "natural" "deflation" can benefit consumers a lot and continuously improve their quality of life. Only "artificial" "deflation" can cause human tragedy like the "Great Depression".

After all, the deflation trap is just an excuse to "bluff". The purpose is to make the behavior of "artificially" interfering in the scale of monetary value gain theoretical legitimacy, thereby legalizing the act of plundering people's wealth through money.

ConclusionWhen the dust of history settles, we clearly see that it is not deflation or inflation that really threatens economic stability, but the invisible hand that artificially manipulates currency. Money is the ruler of civilization, and a stable monetary scale determines the vitality of the economy and the degree of prosperity of society.

The emergence of Bitcoin is precisely because it provides a value yardstick that cannot be arbitrarily tampered with. It gives us a currency that does not need to trust anyone to manipulate, a currency that can truly return to the essence of the market.

Bitcoin is not a deflation trap, it is a channel to get rid of "man-made disasters" and a natural way toward economic prosperity.

Finally, deflation is not a sin, man-made is the culprit;

Value has standards, and prosperity lasts for a long time.