Last month, the Congressional Research Service released a report on Bitcoin analyzing the structure of the network and its implications, if any, on monetary policy. The report was impressive in its accuracy describing Bitcoin’s technical aspects. The report correctly states how the network’s transactions are “pseudononymous” rather than anonymous due to Bitcoin’s use of a “public ledger,” known as the “blockchain,” which publishes all transactions using bitcoins. The report also describes how bitcoins are creating through what is known as “mining.” While the report accurately describes the infrastructure of the Bitcoin network, its criticisms were somewhat lacking.
One key criticism against the network was its deflationary nature. Bitcoin is design to have a fixed supply of total bitcoins (21 million BTC), and as demand for bitcoins increases so will their individual values. This increase in the value of the currency will result in falling prices, relative to the Bitcoin currency in question. The argument is that this will result in hoarding, as people wait for lower prices instead of spending bitcoins now.
It should be noted that deflation is not necessarily a bad aspect of bitcoin’s structure, especially since the report itself notes that a key benefit of Bitcoin is its ability to circumvent dollar inflation. The Friedman Rule was a rule designed by economist Milton Friedman which utilized a built-in deflationary slant to guide Federal Reserve monetary policy.
Within the section on Bitcoin’s deflationary nature was the following passage:
The perils of an inelastic currency were evident, for a period from about 1880 to 1914, when the United States monetary system operated under a gold standard. At this time the deflationary bias of an inelastic supply of gold led to elevated real interest rates, caused periodic banking panics, and produced increased instability of output. The Federal Reserve was created in 1913 to provide an elastic currency.
This time frame, known collectively as the Gilded and Progressive Eras, had two key “panics” (now known as recessions), the Panic of 1893 and the Panic of 1907. In A Monetary History of the United States, 1867-1960, authors Milton Friedman and Anna Jacobson Schwartz discussed these two panics in greater detail.