Recently I started investing in bitcoins and I’ve heard a great deal of talks about inflation and deflation but not many people actually know and consider what inflation and deflation are. But let’s focus on inflation.
We always needed ways to trade value and the most practical way to take action is to link it with money. During the past 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 cover back all of the money it issued. However, during the past century this changed and gold isn’t what is giving value to money but promises. Since you can guess it’s very an easy task to abuse to such power and certainly the major central banks aren’t renouncing to do so. Because of this they are printing money, so put simply they are “creating wealth” out of thin air without really having it. This process not merely 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 money printing? Why are central banks doing this? Well the answer they might offer 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 are able to afford to pay back the debts we’d, basically we make new debts to cover 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 simpler 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 obtain) in your money 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 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 often the opposite of inflation in fact it is the biggest nightmare for our central banks, let’s see why. Basically, See more when overall the costs of goods fall. This would be caused by a rise of value of money. To start with, it would hurt spending as consumers will be incentivised to save lots of money because their value increase overtime. However merchants will undoubtedly be under constant pressure. They’ll need to sell their goods quick otherwise they will lose money as the price they will charge for his or her services will drop over time. But if 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 can be a real burden since it will only get bigger as time passes. 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 means that future generations won’t have much debt to pay (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’re limited in number and we’ll never have more than 21 million bitcoins around. Therefore they are designed to be deflationary. Now we have all seen what the consequences of deflation are. However, in a bitcoin-based future it would still be easy for businesses to thrive. The way to go 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 obtain 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 undoubtedly be distributed more evenly among people. However, just for clarity, I have to say that area 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 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 we inherited from the past generations.