Recently I started investing in bitcoins and I’ve heard a lot of discusses inflation and deflation but not lots of people actually know and think about what inflation and deflation are. But let’s focus on inflation.
We always needed a method to trade value and the most practical way to do it is to link it with money. In past times it worked quite well as the money that was issued was linked to gold. So every central bank had to have enough gold to pay back all of the money it issued. However, in past times century this changed and gold isn’t what’s giving value to money but promises. Since you can guess it’s very easy to abuse to such power and certainly the major central banks are not renouncing to do so. Because of this they are printing money, so put simply they’re “creating wealth” out of thin air without really having it. This process not only exposes us to risks of economic collapse nonetheless it results also with the de-valuation of money. Therefore, because money will probably be worth less, whoever is selling something must raise the price of goods to reflect their real value, that is called inflation. But what’s behind the amount of money printing? Why are central banks doing so? Well the answer they might offer you is that by de-valuing their currency they are helping the exports.
In fairness, in our global economy that is true. However, that is not the only reason. By issuing fresh money we are able to afford to cover back the debts we had, put simply we make new debts to pay the old ones. But that’s not only it, by de-valuing our currencies we have been de-facto de-valuing our debts. That’s why our countries love inflation. In inflationary environments it’s better to grow because debts are cheap. But which are the consequences of most this? It’s hard to store wealth. If you keep carefully the money (you worked hard to get) in your money you are actually losing wealth because your cash is de-valuing pretty quickly.
Because each central bank has an inflation target at around 2% we are able to well say that keeping money costs all of us at least 2% each year. This discourages savers and spur consumes. This is how our economies are working, predicated on inflation and debts.
What about deflation? Well this is often the opposite of inflation in fact it is the biggest nightmare for the central banks, let’s understand why. Basically, we’ve deflation when overall the prices of goods fall. This might be caused by an increase of value of money. To begin with, it could hurt spending as consumers will undoubtedly be incentivised to save lots of money because their value increase overtime. Alternatively merchants will undoubtedly be under constant pressure. They will have to sell their goods quick otherwise they’ll lose money because the price they will charge because of their services will drop as time passes. But when there is something we learned in these years is that central banks and governments usually do not care much about consumers or merchants, what they care the most is DEBT!!. In a deflationary environment debt will become a real burden since it will only get bigger as time passes. Because our economies are based on debt you can imagine exactly what will function as consequences of deflation.
So to conclude, inflation is growth friendly but is founded on debt. Therefore the future generations will pay our debts. Deflation alternatively makes growth harder but it implies that future generations won’t have much debt to cover (in such context it might be possible to cover slow growth).
OK so how all of this fits with bitcoins?
Well, bitcoins are designed to be an alternative for the money and to be both a store of value and a mean for trading goods. They’re limited in number and we’ll never have more than 21 million bitcoins around. Therefore they are designed to be deflationary. We now have all seen what the consequences of deflation are. However, in Bitcoin Evolution -based future it would still be possible for businesses to thrive. The ideal solution will be to switch from the debt-based economy to a share-based economy. In fact, because contracting debts in bitcoins would be very costly business can still have the capital they need by issuing shares of these company. This could be an interesting alternative as it will offer many investment opportunities and the wealth generated will be distributed more evenly among people. However, just for clarity, I must say that section of the costs of borrowing capital will undoubtedly be reduced under bitcoins as the fees will be extremely low and there won’t be intermediaries between transactions (banks rip people off, both borrowers and lenders). This might buffer a number of the negative sides of deflation. Nevertheless, bitcoins will face many problems unfortunately, as governments still need fiat money to cover back the huge debts that people inherited from days gone by generations.