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 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 would be to link it with money. In the past it worked quite well as the money that was issued was associated with gold. So Bitcoin Era had to have enough gold to cover back all the money it issued. However, previously century this changed and gold isn’t what’s giving value to money but promises. As possible 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 are printing money, so basically they’re “creating wealth” out of thin air without really having it. This technique not merely 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 has to 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 so? Well the answer they would 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’s not the only reason. By issuing fresh money we can afford to pay back the debts we had, basically we make new debts to cover the old ones. But that is not only it, by de-valuing our currencies we have been de-facto de-valuing our debts. That is 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. So if you keep carefully the money (you worked hard to obtain) in your money 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 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 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’ve deflation when overall the costs of goods fall. This might be caused by an increase of value of money. To start with, it could hurt spending as consumers will undoubtedly be incentivised to save lots of money because their value will increase overtime. Alternatively merchants will be under constant pressure. They’ll need to sell their goods quick otherwise they’ll lose money because the price they will charge for their services will drop over time. But if 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 over time. Because our economies are based on debt you can imagine what will be the consequences of deflation.
So to conclude, inflation is growth friendly but is based on debt. Therefore the future generations can pay our debts. Deflation however makes growth harder but it implies that future generations won’t have much debt to cover (in such context it will be possible to afford slow growth).
OK so how all of this fits with bitcoins?
Well, bitcoins are made to be an alternative for the money also to be both a store of value and a mean for trading goods. They’re 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 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. Actually, because contracting debts in bitcoins will be very expensive business can still have the capital they need by issuing shares of their company. This could be an interesting alternative as it will offer you 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 undoubtedly be reduced under bitcoins as the fees will be extremely low and there will not be intermediaries between transactions (banks rip people off, both borrowers and lenders). This might buffer a few of the negative sides of deflation. Nevertheless, bitcoins will face many problems unfortunately, as governments still need fiat money to pay back the huge debts that people inherited from the past generations.