Imagine you walk into a bakery, and you ask for a dozen donuts, only to receive 11 donuts. You complain that you asked for 12 donuts and only received 11, but the baker looks at you and says “No, lad. These days a dozen is only 11. You asked for a dozen and I gave you a dozen”. Or you go to a car salesman, and he tells you about a 275 horsepower vehicle he has on offer—that sounds fast! - but when you give it a test drive, it putters along at a snail’s pace. You’d be confused, right? But then he looks you in the eye, and says “Well, but horsepower doesn’t mean what it meant back in the day. Haven’t you been keeping up with the standards published by the government?”
In theory, we could define units to mean whatever we want, and we could make our units have different values from year to year. But in general, we don’t do that, because doing so is stupid—we use units to help us understand and quantify what’s going on, and changing the definitions of units just makes things confusing and makes it harder to keep track of the world. But the one measure which we still do this with is value: one of the functions of a currency is as a unit of value, but the amount of value represented by a dollar today isn’t the same as it was 50 years ago, or what it will be 50 years from now. Economically literate people are already good at adjusting for inflation, which is a hack to get around this, but people do make mistakes failing or forgetting to adjust for inflation, and an ideal unit of value shouldn’t be changing constantly over time.
Note that I’m not saying a currency shouldn’t be inflationary—there are good reasons for currencies to be inflationary (this is particularly true for UBI coins, but also in general) which I won’t get into here, but inflation can be achieved without tampering with the unit of measurement of value—instead of increasing the supply of the coin, you can make user’s accounts decay, so if someone is holding 100 currency at one point in time, they may hold 97 currency two years later, assuming that the account is left untouched. The side effects of doing this are the same as if inflation is implemented in the usual way, but leaves the unit of value untouched. [1]
There are two ways to approach the stabilization of the measurement of value: Either you can hold the total supply of currency fixed, or you can try to track a basket of goods, and maintain a constant exchange rate between that basket and the currency. Tracking a basket makes the most sense if your primary goal is to create a perfectly stable unit of value, however this removes an important dynamic in the modern ecosystem of digital currencies: Many digital currencies become popular due to people investing in the currency in the hope that the value of the currency will rise over time. It’s worth noting that even an inflationary currency can be a good investment, if the rate of inflation / decay is less than the rate of adoption of the currency. As an example, 1 bitcoin was worth $414 five years ago, in March 2016, but is worth $51,000 today, for a annual increase in value of 160% per year. Even if bitcoin inflated at the same rate as the USD (ignoring second-order effects of inflation on price, which do actually matter in the case of BTC), this would have been an amazing investment.
Ideally, you want the unit of value to be stable in the long run, but also to allow flexibility for the currency to grow in the short run, which is why it makes sense for even inflationary currencies to aim to have fixed total supply of currency.
Footnotes:
[1] It makes sense that this isn’t usually done with paper currencies, since it is cumbersome to keep track of decay with paper (although it has been done using costed stamps that are required to maintain the validity of paper bills); but it’s much easier to decay the value of an account with a digital currency
Even Inflationary Currencies Should Have Fixed Total Supply
Imagine you walk into a bakery, and you ask for a dozen donuts, only to receive 11 donuts. You complain that you asked for 12 donuts and only received 11, but the baker looks at you and says “No, lad. These days a dozen is only 11. You asked for a dozen and I gave you a dozen”. Or you go to a car salesman, and he tells you about a 275 horsepower vehicle he has on offer—that sounds fast! - but when you give it a test drive, it putters along at a snail’s pace. You’d be confused, right? But then he looks you in the eye, and says “Well, but horsepower doesn’t mean what it meant back in the day. Haven’t you been keeping up with the standards published by the government?”
In theory, we could define units to mean whatever we want, and we could make our units have different values from year to year. But in general, we don’t do that, because doing so is stupid—we use units to help us understand and quantify what’s going on, and changing the definitions of units just makes things confusing and makes it harder to keep track of the world. But the one measure which we still do this with is value: one of the functions of a currency is as a unit of value, but the amount of value represented by a dollar today isn’t the same as it was 50 years ago, or what it will be 50 years from now. Economically literate people are already good at adjusting for inflation, which is a hack to get around this, but people do make mistakes failing or forgetting to adjust for inflation, and an ideal unit of value shouldn’t be changing constantly over time.
Note that I’m not saying a currency shouldn’t be inflationary—there are good reasons for currencies to be inflationary (this is particularly true for UBI coins, but also in general) which I won’t get into here, but inflation can be achieved without tampering with the unit of measurement of value—instead of increasing the supply of the coin, you can make user’s accounts decay, so if someone is holding 100 currency at one point in time, they may hold 97 currency two years later, assuming that the account is left untouched. The side effects of doing this are the same as if inflation is implemented in the usual way, but leaves the unit of value untouched. [1]
There are two ways to approach the stabilization of the measurement of value: Either you can hold the total supply of currency fixed, or you can try to track a basket of goods, and maintain a constant exchange rate between that basket and the currency. Tracking a basket makes the most sense if your primary goal is to create a perfectly stable unit of value, however this removes an important dynamic in the modern ecosystem of digital currencies: Many digital currencies become popular due to people investing in the currency in the hope that the value of the currency will rise over time. It’s worth noting that even an inflationary currency can be a good investment, if the rate of inflation / decay is less than the rate of adoption of the currency. As an example, 1 bitcoin was worth $414 five years ago, in March 2016, but is worth $51,000 today, for a annual increase in value of 160% per year. Even if bitcoin inflated at the same rate as the USD (ignoring second-order effects of inflation on price, which do actually matter in the case of BTC), this would have been an amazing investment.
Ideally, you want the unit of value to be stable in the long run, but also to allow flexibility for the currency to grow in the short run, which is why it makes sense for even inflationary currencies to aim to have fixed total supply of currency.
Footnotes:
[1] It makes sense that this isn’t usually done with paper currencies, since it is cumbersome to keep track of decay with paper (although it has been done using costed stamps that are required to maintain the validity of paper bills); but it’s much easier to decay the value of an account with a digital currency