Introduction to DogeCoin – Part 2. Inflation vs Deflation. An example of a Deflation Spiral

Inflation vs Deflation

Inflation of a currency is a decline of purchasing value of money. For example, if Dogecoin has 100 Billion coins in circulation one year and 105 Billion coins in circulation the next, this means that the value of each coin goes down because there are more coins today in circulation than a year before that.

Deflation of a currency is an increase of purchasing value of money. An example of deflation would be a currency that had 100 billion coins in circulation a year before and 90 billion today. Because the number of coins is decreasing, each coin is worth more.

While Bitcoin is not deflationary in the way it works and the way it has been designed, there can only be 21 million of Bitcoins. Also, because the network is decentralized, when a person loses the private key of a Bitcoin wallet, the bitcoins in the wallet become lost. Many people also argue that a lot of Bitcoins have been lost because they have been mined in the early days of Bitcoin. Many of the miners were installing Bitcoin software and mining coins just to check out the process and the idea. They didn’t understand the value of Bitcoin and didn’t realize that someday the price of Bitcoin will surpass $10,000, which is why they didn’t make backups of private keys of the bitcoin wallets and the bitcoins got destroyed together with old computers and old hard drives.

Both inflation and deflation have their own pros and cons. Most central banks on the planet aim for the inflation of 2%. This number is not too far from Dogecoin’s inflation rate. The banks argue that small inflation is healthy because it allows countries to adjust wages of workers in a proper way, adjust prices of goods and services, and avoid the deflationary spiral.

The value of labor in the economy changes all the time. For example, in the 1960s and 1970s, the value of manual labor in America was very high. It was possible to graduate from high school, get a job at a factory and eventually get to a six-figure income, buy a home, a boat and have an RV in the driveway. These times are long gone mostly because of automation of labor and outsourcing of production. However, the salaries of such workers did not go down. It was inflation of the currency that made the salaries smaller in value while nominally they stayed the same.

Many economists argue that this is one the main reasons why inflation is necessary. Here is there argument: if salaries were to go down nominally instead of going down in value (for example, someone would get a decrease in salary from $75,000/year to $65,000/year instead of keeping the same salary that goes down in value because of inflation), people would stop spending as freely as they did before. They would need to create a budget based on the $65,000 instead of $75,000, which means that they will have to cut spending on goods and services. This would lead to less economic growth and fewer jobs. Therefore, inflation is necessary.

 

An example of deflationary spiral

Proponents of inflation and coins such as Dogecoin also say that inflations helps avoid deflationary spiral and risks associated with it.

Here’s is an example of a deflationary spiral. Let’s say there is an economy that consists of just two products, mangos, and broccoli. Both mangos and broccoli are perishable foods and can go bad with time. For this reason, neither of them can become a long-term currency. For this reason, people start using silver as currency. They see silver as a tool that allows them to store value. They can exchange silver into mangos or broccoli at any time. A problem occurs when the economy starts growing. Suddenly, there are more mangos and more broccoli, but the same amount of silver. In economic terms, the supply of mangos and broccoli has increased and the supply of silver stayed the same. This means that the price of mangos and broccoli will go down. For example, if previously 1 silver coin was equal to 1 mango or 1 lb of broccoli, as the economy grows, 1 silver coin would be able to buy 1.5 mangos or 2 mangos.

This is likely to lead to coin hoarding. People would realize that the value of coins goes up because tomorrow they will be able to buy more with the coins than they do today. A lack of supply of currency in the marketplace because of coin hoarding would lead to prices declining even further down. Eventually, it will make no sense for farmers to keep producing mangos and broccoli and the markets would collapse. This is an example of a deflationary spiral.

As of the beginning of 2018, both Bitcoin and Dogecoin are doing really well in the marketplace. This means that the market has room for both deflationary digital coins and inflationary digital coins.