alt Hacker NewsOne of the weird things about our world is that money is central to everything, but it’s hard to understand how it works. There’s a great deal of handwaving around how, for example, dollars are created, much of which is, in fact, not correct at all (most dollars are created not by the government, or even the Federal Reserve, but by private banks, via a mechanism which I will not pretend to fully understand).
The big flaw of Bitcoin, to my mind, is that it is an inherently deflationary currency. Deflation is one of those things that seems great on the surface: prices go down, not up, but when that happens it ends up creating an economic incentive to avoid spending since why buy something today if it will be cheaper tomorrow, and this ends up causing economic activity to slow down or stop entirely. A small amount of inflation, on the other hand creates an incentive to either spend money or invest it in something that will provide a better than inflation return, whether that’s putting it in a high-yield savings vehicle or making capital or financial investments. With deflation, you can just leave your funds in cash (where they will not provoke any economic growth) and get a return.
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Allen Farrington makes a solid case in this essay [1] about deflation being the more effective mode of economy.
I thought private banks create money the moment they take out a credit from the central bank. The central bank's job is to set the interest rate for those loans, et viola.
I’d argue that this is more of a feature than a bug.
The assumption behind the “deflation is bad” argument is that spending itself is the goal. But spending is not automatically good. Productive spending and productive investment are good. Wasteful consumption, speculation, and forced risk-taking are not.
If money holds its value, people become more selective. They still buy food, housing, tools, entertainment, experiences, and things they genuinely want. Humans have needs, preferences, status impulses, advertising pressure, and finite lives. Demand does not disappear just because money is sound. What disappears is some of the artificial urgency to spend before your cash loses value.
The more important point is investment. In an inflationary system, holding money is punished, so everyone is pushed out onto the risk curve. You are not only investing because an opportunity is great; you are investing because the currency is being diluted and you need to escape it. That distorts the real cost of capital and makes mediocre investments look better than they are in nominal terms.
With harder money, investment has to beat the return of simply holding the money. That is a healthy hurdle rate. Capital should have to prove that it creates real value. If an investment only makes sense because the denominator is being debased, or because everyone is forced into assets to avoid inflation, then maybe that investment was not as productive as it looked.
This also matters for inequality. Inflation does not hit everyone equally. People with capital can protect themselves by owning stocks, real estate, ETFs, businesses, and other assets. They can diversify, borrow against assets, and ride asset inflation. Poorer people are more likely to hold wages and cash, so they are the ones whose purchasing power gets diluted first. Then they are told to “just invest,” but they are competing against people who already have capital, better access, better tax treatment, and more room to take risk.
So inflationary money quietly forces the poor to compete with the rich on the rich person’s playing field: asset ownership. A broad ETF may look like a safe wealth-preservation tool for someone with money, but for someone living paycheck to paycheck, the need to buy risk assets just to avoid being diluted is itself a problem.
A deflationary or hard-money system would probably reduce some marginal consumption and speculative investing. But that is not obviously bad. It may mean fewer bad investments, less artificial asset inflation, and more pressure for capital to flow only into things that genuinely outperform money itself. It would also be much more sustainable, not just economically but materially: if money no longer pressures everyone to consume and invest constantly just to outrun debasement, there is less incentive to waste real-world resources on unnecessary production, overconsumption, and short-lived goods.
The fear is that nobody would spend. But people do not stop buying things just because they expect their money to hold value. They stop buying things that are not worth giving up good money for. That sounds like discipline, not economic failure.
> most dollars are created not by the government, or even the Federal Reserve, but by private banks, via a mechanism which I will not pretend to fully understand
Fractional reserve banking. Basically, bankers start getting very anxious when they see the masses of people depositing mountains of cash into them. They look at the cash hoard they have suddenly amassed and think, we can't just leave this pile of cash here doing nothing, we have to efficiently allocate all of this capital. So they lend it out to people who need cash, charge interest and pay account holders their yields.
Deposit $100. Bank loans out $90, and $10 sits in its reserves. Your account still says $100, even though the bank is now leveraged against loans to third parties. Guy who took the $90 loan pays some bills, and that $90 ends up deposited right back into the same bank. So it keeps $9 and loans out $81. There is now $100 + $90 + $81 in circulation, but only that $100 is real money, the rest are all made up. They only become real when loans are repaid. So, the $81 gets spent, deposited back into the bank, and so on, and so forth, expanding the money supply like a fractal until the amounts become too infinitesimal to track. Thus $1,000 easily becomes $100,000 literally overnight. Government could run its presses 24/7 and it would not be able to outcompete the banks when it comes to inflating the money supply.
Banks are the financial call stacks of society. Better hope there aren't any exceptions (defaults), or the whole thing unwinds and comes crashing down.
It's like a society wide financial version of ISP oversubscription. The assumption is nobody is going to stress test the system by saturating the link 24/7. Everything breaks the second the invariants are violated. Banks similarly assume that not everybody will need all of their dollars immediately, which lets them "efficiently allocate" all of those dollars. Entire government systems exist just to bail out the banks where this assumption fails to be load bearing.