Recently I started investing in bitcoins and I’ve heard a great deal of talks about inflation and deflation however, not lots of people actually know and consider what inflation and deflation are. But let’s start with inflation.
Bitcoin Era Official needed a method to trade value and probably the most practical way to take action is to link it with money. In past times it worked quite well because the money that was issued was associated with gold. So every central bank had to have enough gold to pay back all the money it issued. However, in the past century this changed and gold isn’t what is giving value to money but promises. As possible guess it’s very easy to abuse to such power and certainly the major central banks aren’t renouncing to do so. That is why they’re printing money, so quite simply 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 is worth less, whoever is selling something must increase the price of goods to reflect their real value, that is called inflation. But what’s behind the money printing? Why are central banks doing this? Well the answer they would give you is that by de-valuing their currency they are helping the exports.
In fairness, inside our global economy this is true. However, that is not the only reason. By issuing fresh money we can afford to cover back the debts we had, put simply we make new debts to cover the old ones. But that is not only it, by de-valuing our currencies we are de-facto de-valuing our debts. That’s why our countries love inflation. In inflationary environments it’s easier to grow because debts are cheap. But which are the consequences of most this? It’s hard to store wealth. So if you keep the money (you worked hard to obtain) in your bank account you are actually losing wealth because your money is de-valuing pretty quickly.
Because each central bank comes with an inflation target at around 2% we can well say that keeping money costs most of us at least 2% each year. This discourages savers and spur consumes. This is one way our economies are working, predicated on inflation and debts.
What about deflation? Well this is exactly the opposite of inflation and it is the biggest nightmare for our central banks, let’s understand why. Basically, we have deflation when overall the prices of goods fall. This would be caused by a rise of value of money. To begin with, it would hurt spending as consumers will be incentivised to save money because their value increase overtime. On the other hand merchants will undoubtedly 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 as time passes. But when there is something we 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 as time passes. Because our economies are based on debt you can imagine exactly what will be the consequences of deflation.
So to summarize, inflation is growth friendly but is based on debt. Which means future generations will pay our debts. Deflation alternatively makes growth harder but it implies that future generations won’t have much debt to pay (in such context it could be possible to cover slow growth).
OK so how all this fits with bitcoins?
Well, bitcoins are made to be an alternative for money also to be both a store of value and a mean for trading goods. They are limited in number and we will never have more than 21 million bitcoins around. Therefore they’re designed to be deflationary. We now have all seen what the consequences 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 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 want by issuing shares of these company. This could be an interesting alternative as it will offer many investment opportunities and the wealth generated will undoubtedly be distributed more evenly among people. However, just for clarity, I must say that portion of the costs of borrowing capital will be reduced under bitcoins because the fees would be extremely low and there won’t be intermediaries between transactions (banks rip people off, both borrowers and lenders). This might 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 people inherited from days gone by generations.