Currency is the ruler of civilization; a stable measure of currency determines the vitality of the economy and the level of social prosperity.
On March 24, Strategy (formerly MicroStrategy) made a significant move again—buying 6,911 Bitcoins at an average price of $84,000, bringing its total Bitcoin holdings to over 500,000, with an average cost of $66,000. At the current price of about $88,000, the company has a paper profit of $22,000 per Bitcoin.
It is not hard to see that no matter which time point one stands at, looking at the global wave of cryptocurrencies, Bitcoin remains the most dazzling presence. Yet since its inception in 2009, it has never escaped controversy. Especially in the economic community, doubts about Bitcoin have been incessantly raised. One of the most cited criticisms comes from Nobel laureate Paul Krugman.
Krugman pointedly noted that if an economic system is based on Bitcoin, due to its fixed total supply, it would likely lead to a rigid money supply, triggering deflation. He warned that this 'deflation trap' would induce people to delay consumption, corporate profits to decline, and waves of layoffs to surge, ultimately leading to a vicious cycle of economic recession. I have also conducted an in-depth analysis of this viewpoint in my writing (Bitcoin Should Be Our Mirror).
Today, the 'deflation trap' has become one of the common reasons many countries resist Bitcoin. But the question is, does this argument really hold? Is deflation truly an inescapable fate for Bitcoin? Or is it just a misunderstanding of the new thing by traditional paradigms?
To answer this question, we must first clarify:
What is deflation?
How does deflation occur?
Only by deeply understanding these two questions can we truly determine whether Bitcoin and deflation are antagonists or misunderstood.
We've talked a lot about Bitcoin; as for 'deflation,' you might still feel somewhat unfamiliar. Fortunately, the book (Bitcoin Standard) can help us catch up on this lesson.
1. What is deflation?
Deflation is short for deflationary currency. To put it simply: currency is essentially the money we commonly refer to. Deflation means there is less money in the market.
To deeply understand deflation, we must first start from its opposite—inflation; and to discuss inflation, we must first talk about the concept of 'money supply.' Only by clarifying the connotations of money supply can we truly understand the internal logic of inflation and deflation.
The money supply is usually represented by 'M' and is divided into several levels based on the strength of monetary liquidity. The most commonly used are M1 and M2.
M1 is referred to as 'narrow money'; it includes cash (paper money and coins) as well as demand deposits, which can be used for consumption at any time and have high liquidity. For example, the cash in your wallet and the electronic payment balance on your phone fall under the category of M1.
M2 is referred to as 'broad money'; it includes not only M1 but also time deposits, savings accounts, and money market funds, which are relatively less liquid assets. Although these funds cannot be consumed at any moment, they can usually be converted into liquid cash with a certain time lag or by incurring a small interest loss.
The occurrence of inflation or deflation hinges on the relationship between monetary supply indicators like M1 and M2 and the supply of goods and services.
When the money supply (such as M2) grows faster than the supply of goods and services, too much money chases relatively limited goods and services, driving up overall prices; this is 'inflation.' According to Federal Reserve data, after the pandemic in 2020, the U.S. implemented massive monetary easing policies, and the M2 supply grew an astonishing 24% throughout 2020, as shown below. This flood of money directly led to an inflation rate of 7% in the U.S. in 2021, the highest in nearly 40 years, with consumers clearly feeling the rapid rise in the prices of daily necessities, food, and energy.
Deflation is quite the opposite. When the growth rate of the money supply is less than the rate at which goods and services are supplied, or when the money supply decreases absolutely, the money in the market becomes increasingly 'scarce'; the same amount of currency can naturally buy more and more goods, leading to a general decline in prices—this is 'deflation.'
The most classic case of deflation in history is the Great Depression in the United States during 1929. At that time, a large number of banks failed, and both M1 and M2 contracted sharply. This significant reduction in money directly led to a depletion of market liquidity, a drastic drop in prices, rapid shrinkage of corporate profits, and a subsequent wave of layoffs, plunging the entire economy into a negative spiral. What exactly happened during the Great Depression? How did deflation occur? This will be discussed in detail later.
In contrast, inflation is like a 'fever'; too much money leads to an economic 'fever,' easily resulting in speculative bubbles and wealth shrinkage; while deflation is like a 'cold'; less money leads to a frozen economy, with people unwilling to consume, and businesses hesitant to invest, gradually stalling economic activities.
Next, let's take a look at the Great Depression that occurred in the 1930s, as it was caused by deflation.
2. The Great Depression, a terrifying deflation?
Whenever deflation is mentioned, people usually think of the winter of economic recession, as if the entire society has fallen into a frozen state.
The most direct association is often this black-and-white photo from the Great Depression of the 1930s: in February 1931, unemployed workers lined up outside a soup kitchen in Chicago.
During that period, the United States experienced severe deflation, with prices plummeting like a kite with a broken string. Historical data shows that from 1929 to 1933, the consumer price index (CPI) in the U.S. fell by about 25%. This means that if you had $100 in 1929, by 1933, that $100 would have the purchasing power equivalent to about $133 today. This may sound like a good thing, but the reality was far from it.
Why is that?
Because deflation does not merely mean a decline in commodity prices; it can freeze the entire economic cycle. Imagine that when people expect prices to drop tomorrow, no one is willing to consume today. U.S. retail sales plummeted from $48.4 billion in 1929 to $25.1 billion in 1933, nearly halving. The sharp drop in consumption led to massive inventory backlogs for businesses, plunging profits, and large-scale layoffs. This further undermined consumer confidence, with the unemployment rate soaring from 3.2% in 1929 to a shocking 24.9% in 1933, pushing a quarter of the workforce onto the streets. The economy fell into a bottomless whirlpool, struggling yet sinking deeper.
But now I tell you, deflation has not only a terrifying side but also a charming side; you may find it strange.
3. Prosperity, the charming deflation?
People often closely associate deflation with depression, but history tells us that deflation does not necessarily lead to economic recession; sometimes it can even accompany unprecedented prosperity. The most typical example is the period known as 'La Belle Époque' in the late 19th century.
In fact, similar phenomena had occurred in human history even before the wonderful years. For example, during the Renaissance, Florence and Venice quickly rose to become centers of European economy, art, and culture, largely due to their early adoption of a stable and reliable monetary standard.
3.1 Gold Coins and the Renaissance
In 1252, Florence issued the famous Florin gold coin. The emergence of the Florin gold coin was significant; it marked the first time since the era of Roman Emperor Caesar that Europe had a highly pure and reliable gold currency. Each Florin gold coin weighed about 3.5 grams, with a gold content of 24 karats, and its stable purity and fixed weight quickly made it the standard currency for trade in Europe at that time.
The reliability and stability of the Florin gold coin quickly elevated Florence's position in the European economy and spurred the vigorous development of the banking industry. The bankers of Florence at that time, such as the famous Medici family, provided services such as deposits, loans, exchanges, and currency conversion through branches spread across Europe, laying the foundation for the modern banking system. With the support of the Florin gold coin, merchants across Europe could confidently engage in international trade without worrying about losses from currency depreciation and exchange rate fluctuations.
Subsequently, in 1270, Venice followed Florence's lead and minted its own Ducat gold coins, identical to the specifications and fineness of the Florin gold coins, allowing this reliable currency standard to spread rapidly across the European continent. By the end of the 14th century, over 150 countries and regions in Europe had issued gold coins similar to the Florin standard. The uniformity and reliability of this currency greatly simplified international trade processes and accelerated the flow of capital and wealth accumulation within Europe.
It was under the robust monetary system built by gold coins that Florence became the core city of the Renaissance. Stable currency not only fostered economic prosperity but also created a rich soil for the development of art and humanities. The Medici family, leveraging the immense wealth brought by banking, sponsored numerous artistic masters such as Michelangelo, Da Vinci, and Raphael. These artistic giants were able to devote themselves to creation without distractions, producing great works such as Michelangelo's statue of David, Da Vinci's Mona Lisa, and Brunelleschi's design of the Florence Cathedral dome, truly promoting the renaissance and prosperity of human civilization.
Of course, the era that best represents deflationary prosperity is the wonderful years of the late 19th century. During this period, deflation and economic prosperity combined wonderfully, creating an unparalleled golden age in human history.
3.2 The deflationary prosperity of the wonderful years
'The Wonderful Years' roughly began with the end of the Franco-Prussian War in 1871 and ended before the outbreak of World War I in 1914.
The stable monetary system established by gold coins not only gave rise to the glory of Florence and Venice during the Renaissance but also achieved the perfect integration of economic prosperity and technological innovation in the 'Wonderful Years' of the late 19th century.
During this period, major countries around the world adopted a unified gold standard, making currency exchange extremely simple. Currencies from different countries were essentially different weights of gold. For example, at that time, the British pound was defined as 7.3 grams of gold, the French franc as 0.29 grams, and the German mark as 0.36 grams, with the exchange rates naturally fixed. For instance, £1 could always be exchanged for 26.28 francs and 24.02 marks, making global trade as straightforward as measuring length, truly realizing the vision of global free trade.
Under this gold standard system, without the interference of central bank monetary policy, how much currency people hold entirely depends on their needs, rather than being manipulated by the government or central banks. The reliability of money encouraged saving and capital accumulation, promoting rapid industrialization, urbanization, and technological advancement.
In this stable monetary environment, social productivity soared. The wonderful years saw a plethora of significant innovations and inventions that changed the world:
In 1876, Bell invented the telephone;
In 1885, Karl Benz developed the first internal combustion engine car;
The Wright brothers achieved the first powered flight in 1903;
In 1870, the total length of railways in the United States was about 50,000 miles; by 1900, it had expanded to 190,000 miles, fundamentally changing people's lives and business models.
The medical field was even more shocking, with breakthroughs in heart surgery, organ transplants, X-rays, modern anesthesia, vitamins, and blood transfusion technology concentrated in this period. These innovations not only improved productivity but also significantly enhanced human quality of life and longevity.
The rise of petrochemical technology also gave birth to key materials such as plastics, nitrogen fertilizers, and stainless steel, significantly enhancing agricultural and industrial production efficiency, making a large number of goods cheaper and more accessible.
As economist Ludwig von Mises stated: '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 culture and art also cannot be separated from the support of a stable monetary system. Just as in the Renaissance period of Florence and Venice, during the wonderful years, European centers like Paris and Vienna also saw a surge of artistic masters. These artists and thinkers benefited from patient investors with low time preferences who supported artistic creation, promoting the flourishing of neoclassicism, romanticism, realism, and impressionism.
The reason 'The Wonderful Years' is so nostalgically remembered in history is not only because it achieved unprecedented economic growth but also because it combined deflation and economic prosperity in a wonderful way. The continuous decline in prices did not lead to stagnant consumption; rather, it allowed people to enjoy a higher quality of life with less money.
The facts show that deflation does not necessarily lead to economic recession. So, you might want to ask:
So why did the deflation that began in 1929 lead to the Great Depression?
Why do the same deflationary conditions yield different results?
If deflation is 'innocent,' then who is 'guilty'?
We must deeply understand the ins and outs of the Great Depression to unearth the true causes, allowing us to answer the above questions.
4. How was the Great Depression formed step by step?
Going back to the 1920s, you will find it was a world filled with gold. The Great Depression occurred against this backdrop. All this stemmed from the Federal Reserve's extremely loose monetary policy in the early 1920s.
In order to help stabilize the pound and prevent gold outflows from Britain, the Federal Reserve lowered the discount rate from 4% to 3% between 1924 and 1928. Although it seemed like only a 1 percentage point cut, it greatly stimulated demand for funds in the market, as if it opened the floodgates, with dollars flooding into the economy.
In this environment of extremely loose monetary policy, investors found loans unusually cheap, as if free lunches were everywhere. According to (Bitcoin Standard), during the period from 1921 to 1929, the money supply in the United States grew an astonishing 68.1%, far exceeding the 15% growth in gold reserves.
Consequently, a large amount of cheap capital flooded into the stock market, with the Dow Jones index soaring from 63 points in 1921 to 381 points in September 1929, an increase of over 500% in eight years. The market frenzy reached an incredible level, with even ordinary workers, taxi drivers, and housewives borrowing to speculate in stocks.
Economist Irving Fisher confidently asserted on October 16, 1929, that the stock market had reached a 'permanent plateau,' believing that high stock prices would not decline further. However, just a week later, on October 24, 1929, the U.S. stock market began to plummet, and the bubble burst completely.
In fact, as early as the end of 1928, the Federal Reserve had already sensed the risk of an asset bubble and began tightening monetary policy, raising interest rates in an attempt to cool the overheated economy.
However, the sudden turn of the Federal Reserve shocked the market: high interest rates shattered the fantasy of continuously rising asset prices, and the bubble burst rapidly. October 24, 1929, 'Black Thursday,' marked the beginning of the stock market crash.
After the stock market bubble burst, all the cheap loans turned into heavy burdens; bank loans became unrecoverable, and cash flow rapidly dried up, triggering a massive wave of bank runs.
At this time, the Federal Reserve should have actively provided liquidity to the banking system to prevent panic from spreading, but the Federal Reserve took a relatively passive stance. Allowing banks to fail in large numbers further deteriorated public confidence, with total bank deposits decreasing by about one-third and the M2 money supply plummeting by over 30%. From 1929 to 1933, about 10,000 banks failed in the U.S.
Of course, the erroneous policies of the American government further exacerbated the situation. Both President Hoover and his successor Roosevelt implemented a series of interventionist policies, including fixing wages and setting price controls, in an attempt to 'freeze' the economy at the levels of prosperous times. For instance, to maintain agricultural prices, the government absurdly resorted to measures like burning crops, which seemed especially ridiculous against the backdrop of economic depression and people starving.
Having reached this point, you should understand:
The deflation of the Great Depression was not of the natural kind seen in the wonderful years, but rather a consequence of the Federal Reserve's mismanagement.
Economist Milton Friedman believed that if the Federal Reserve had quickly increased the money supply at that time, the wave of bank failures and runs could have been mitigated, thus avoiding the subsequent long-term recession.
However, the author of (Bitcoin Standard) points out that Friedman ignored the root of the problem: the economy had been severely distorted by artificial monetary expansion in the 1920s. After the stock market bubble burst, simply injecting more currency into the market could not genuinely solve the serious mismatches in economic structure; it would only make future crises more ferocious.
In other words, if there had been no monetary expansion starting in 1921, there would also not have been a sudden tightening of money later, and thus, the Great Depression lasting 10 years would not have occurred.
So why did the U.S. engage in monetary expansion for Britain in 1921? Was America really doing a good deed?
5. Was the Great Depression caused by America's altruism?
The extremely loose monetary policy adopted by the Federal Reserve in the early 1920s ostensibly aimed to help the Bank of England prevent gold outflows and maintain the pound's exchange rate, but it was not simply out of 'altruism.' In fact, the U.S. also had clear self-interest considerations.
To understand this issue, we need to return to the economic landscape after World War I.
5.1 Britain's 'High Aspirations'
Before the war, London was the center of the world financial system, and the pound was the core currency of global trade and reserves. However, the war severely weakened the British economy, forcing the Bank of England to issue a large amount of currency without sufficient gold reserves to support it, causing the pound to decouple from gold and its value to fluctuate dramatically.
After the war, Britain was eager to revive London as the global financial center. In 1925, British Chancellor Winston Churchill announced the restoration of the gold standard, restoring the exchange rate of the pound to gold at pre-war high levels, namely £4.86 per ounce of gold. This decision, seemingly wise, buried serious hidden dangers for the British economy.
Why? Because after the war, Britain's production capacity and economic strength had significantly declined, and the pound no longer had its pre-war purchasing power. If the pre-war overvalued pound exchange rate was forcibly restored, British goods would become extremely uncompetitive, leading to a massive shock to British exports. A large amount of gold would quickly flow out of Britain to the economically stronger United States.
In fact, this situation did occur. Britain's gold reserves rapidly declined after restoring the gold standard, creating a very severe situation. If this continued, Britain might have to abandon the gold standard again, further undermining the international credibility of the pound. This was something the British government absolutely did not want to see.
But why was America willing to help Britain? Is America simply doing a good deed?
Not at all.
5.2 The United States of 'Mutual Necessity'
At that time, the Federal Reserve and Wall Street elites had clear strategic goals. They hoped to use this opportunity to gradually replace London as the global financial center. In other words, Wall Street was willing to temporarily maintain British financial stability through loose monetary policy, hoping to avoid a rapid collapse of Britain due to gold outflows.
Why? Because if the British economy suddenly collapsed, the entire European financial system might also collapse. This would not be good for the United States. During World War I, the U.S. provided a large amount of loans to Europe, and a stable economic environment in Europe was crucial for the U.S.
Furthermore, helping Britain stabilize its finances also aligned with the long-term interests of Wall Street bankers at that time. Many major American banks had close ties with the City of London and held substantial assets and debts in Britain. If the pound's exchange rate plummeted, the value of these assets would also dramatically shrink.
In simple terms, American financiers did not wish to see the British financial market crash prematurely, as this would affect their substantial interests in Britain.
5.3 The 'counterproductive' interest rate cuts
Thus, for the sake of Britain, and also for itself, the Federal Reserve implemented a series of loose policies between 1924 and 1928, lowering the discount rate from 4% to 3%. On the surface, this seemed like only a slight interest rate cut, but in reality, it was akin to opening the floodgates of money, leading a massive influx of dollars into the market. American banks quickly lent out this cheap capital, stimulating the economy and inflating asset prices, creating the illusion of prosperity in the 1920s.
This strategy did indeed work in the short term. The outflow of gold from Britain was temporarily alleviated, and the pound briefly stabilized, delaying the collapse of London’s financial market. But the problem is that this man-made intervention policy suppressed U.S. market interest rates, causing severe economic distortions.
Specifically, excessively low interest rates encouraged blind investments by businesses and individuals, stimulating a speculative frenzy in real estate and the stock market. From 1921 to 1929, the Dow Jones Industrial Average rose more than 500%, and real estate prices soared, ultimately forming a massive asset bubble.
From a larger historical perspective, the Federal Reserve's policy was not merely altruistic but rather a strategic arrangement by American elites seeking to gain financial dominance through helping Britain. Although it protected American economic interests and asset safety in Europe in the short term, it ultimately sowed greater hidden dangers for the U.S. economy.
It has been proven that such short-sighted policies ultimately backfired. After the bubble burst in 1929, the Federal Reserve and the U.S. government not only failed to avert the crisis but instead led the U.S. economy into an unprecedented recession. This Great Depression was precisely caused by previous artificial manipulation of the money supply and interest rates.
(Bitcoin Standard) authors point out that it was indeed the actions of the Federal Reserve in the 1920s that led to the subsequent disastrous economic consequences.
Now, we can finally see clearly:
Deflation itself is not frightening; what is frightening is the arbitrary manipulation of currency and interest rates by central banks.
Returning to the beginning, it should be clear whether the fixed money supply represented by Bitcoin will cause the 'deflation trap.'
6. Is the deflation trap merely a 'man-made disaster'?
The reason currency can be widely accepted and used is that it has a stable measure of value. This stability is like a precise ruler, allowing people to confidently calculate costs, revenues, and future returns in complex economic activities.
But the problem lies precisely in the fact that the value measure of traditional fiat currency is not stable; it can fluctuate wildly due to central bank policies. The painful lessons of the Great Depression in 1929 precisely prove this point: artificially manipulating the money supply and interest rates undermined the foundation of currency as a stable measure of value. This artificially induced deflation is the real disaster.
On the contrary, if deflation is caused by natural price declines due to increased production efficiency and technological progress, such deflation is not destructive but has enormous positive significance. The historical 'wonderful years' and the Renaissance period are the best examples of the brilliant achievements brought by this 'natural deflation.'
Previously, we have discussed the industrial revolution during the deflationary period of the late 19th century;
From 1870 to 1900, the cumulative consumer price index (CPI) in the United States fell by about 30%, meaning that prices averaged a decline of about 1% per year.
Steel production soared from 20,000 tons in 1865 to 10 million tons in 1900;
The output of the manufacturing industry grew by more than 500%.
This indicates that the gradual decline in prices is actually a reflection of economic prosperity, rather than a precursor to economic stagnation.
To give a more modern example: from 1980 to 2000, the U.S. technology industry thrived, with computer prices dropping by nearly 90%, while functionality improved by thousands of times. Similarly, the prices of smartphones continued to decrease, with features evolving rapidly. Consumers did not stop buying because they expected 'computers to be cheaper next year'; on the contrary, they continued to buy better devices because demand itself is not infinitely postponable.
In fact, this 'natural' deflation can greatly benefit consumers, continuously improving their quality of life. Only 'man-made' deflation can cause human tragedies like the 'Great Depression.'
Ultimately, the deflation trap is merely an 'intimidating' excuse. Its purpose is to provide theoretical legitimacy for 'artificial' interventions in the measure of currency value, thereby legitimizing actions that plunder the wealth of the populace through currency manipulation.
Conclusion
When the dust of history settles, we clearly see that the real threat to economic stability is not deflation or inflation, but the invisible hand of human manipulation of currency. Currency is the ruler of civilization; a stable measure of currency determines the vitality of the economy and the level of social prosperity.
The emergence of Bitcoin precisely provides a measure of value that cannot be arbitrarily manipulated. It gives us a currency that does not require trust in any human manipulation, a currency that can truly return to the essence of the market.
Bitcoin is not a deflation trap; it is a pathway to escape 'man-made disasters' and a natural route towards economic prosperity.
Ultimately:
Deflation is not guilty; it is the human manipulation that is to blame; value has a measure, and prosperity lasts long.