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Bitcoin Explained Like You’re Five: Part 5 – Macroeconomics

• ChrisPacia.Wordpress.Com

Wrapping your head around Bitcoin can be a pretty monumental task. I’ve tried to simplify some of the technical aspects in the first four parts of this series. Often new Bitcoiners find themselves not only trying to learn some basic cryptography but also economics and monetary theory as well! Given the complexity of the subject and all the information (and disinformation) out there, it can be extremely difficult to find clarity. In this post I’m going to provide a brief introduction to macroeconomics as it relates to Bitcoin. Obviously, I can’t condense an entire textbook into a short blog post, so I’m going to make a lot of generalizations, but hopefully you’ll still come away with the main points.

Let me state up front that there isn’t anywhere close to a consensus among macro-economists as to what constitutes correct theory. Anyone who tries to convince you otherwise is being disingenuous. Most critics stress that widespread use of Bitcoin would certainly cause economic calamity. Maybe it will, maybe it wont, but it’s foolish to speak with such certainty when the economics is far from settled. I tend to believe that the critics are wrong, but I’ll at least give you a fair overview of both sides.

It’s The Aggregate Demand, Stupid

Some version of the following theory of economic recessions is held by a majority economists. It could be considered the “mainstream” theory to the extent there is such a thing.

Let’s start by asking what would happen if one day people just suddenly reduced their spending and increased their rate of savings? In this context we’re focusing on the saving of cash, not investment spending. Another way of putting it would but to say that the aggregate demand for goods and services suddenly falls (with a corresponding increase in people’s cash balances).

Classical economists would have responded by saying that prices and wages would just simply adjust downwards. Remember that wages and prices are determined by supply and demand. If aggregate demand were to fall (if cash savings were to increase) all prices in the economy would adjust downwards and the economy would establish a new equilibrium at a lower price level. We would experience a general deflation, but there would be no reason to expect this would have any negative impact on employment or production. In other words, a sudden increase in cash savings would not cause a recession.

 

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