Recently I started buying bitcoins and I’ve heard a great deal of talks about 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 way to trade value and probably the most practical way to do it would be to link it with money. In past times it worked quite well because the money that has been issued was associated with gold. So every central bank had to have enough gold to pay back all of the money it issued. However, before century this changed and gold is not what is 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. That is why they’re printing money, so in other words they are “creating wealth” out of thin air without really having it. This process not only exposes us to risks of economic collapse but it results also with the de-valuation of money. Therefore, because money will probably be worth less, whoever is selling something must increase the price of goods to reflect their real value, this is called inflation. But what’s behind the money printing? Why are central banks doing this? Well the answer they would offer you is that by de-valuing their currency they’re helping the exports.
In fairness, inside our global economy this is true. However, that’s not the only real reason. By issuing fresh money we are able to afford to cover back the debts we had, basically we make new debts to pay the old ones. But that’s not only it, by de-valuing our currencies we are de-facto de-valuing our debts. That is why our countries love inflation. In inflationary environments it’s easier to grow because debts are cheap. But what are the consequences of all this? It’s hard to store wealth. If you keep the money (you worked hard to get) in your bank account you’re actually losing wealth because your cash is de-valuing pretty quickly.
Because each central bank comes with an inflation target at around 2% we are able to well say that keeping money costs most of us at least 2% per year. This discourages savers and spur consumes. This is one way our economies are working, based on inflation and debts.
What about deflation? Well this is exactly the opposite of inflation in fact it is the biggest nightmare for the central banks, let’s see why. Basically, we have deflation when overall the costs of goods fall. This might be caused by a rise of value of money. To start with, it would hurt spending as consumers will undoubtedly be incentivised to save lots of money because their value will increase overtime. On the other hand merchants will be under constant pressure. They will need to sell their goods quick otherwise they will lose money because the price they will charge for his or her services will drop over time. But if there is Bitcoin Era Official learned in these years is that central banks and governments 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 as it will only get bigger over time. Because our economies are based on debt you can imagine what will function as consequences of deflation.
So to conclude, inflation is growth friendly but is founded on debt. Therefore the future generations can pay our debts. Deflation on the other hand 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 made to be an alternative for money and to be both a store of value and a mean for trading goods. They are limited in number and we will never have a lot more than 21 million bitcoins around. Therefore they are designed to be deflationary. We now have all seen what the results of deflation are. However, in a bitcoin-based future it could still be possible for businesses to thrive. The ideal solution will be to switch from a debt-based economy to a share-based economy. Actually, because contracting debts in bitcoins will be very expensive business can still have the capital they want by issuing shares of these company. This could be a fascinating alternative as it will offer you many investment opportunities and the wealth generated will be distributed more evenly among people. However, simply for clarity, I have to say that part of the costs of borrowing capital will undoubtedly be reduced under bitcoins as the fees would be extremely low and there will not be intermediaries between transactions (banks rip people off, both borrowers and lenders). This would buffer some 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 we inherited from days gone by generations.