Recently I started investing in bitcoins and I’ve heard a lot of discusses inflation and deflation however, not many 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 is to link it with money. In Click here worked quite well as the money that was issued was linked to gold. So every central bank needed enough gold to cover 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. As possible guess it’s very an easy task to abuse to such power and certainly the major central banks are not renouncing to do so. Because of this they’re printing money, so put simply they’re “creating wealth” out of nothing without really having it. This technique 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, this 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’re helping the exports.
In fairness, inside our global economy that is true. However, that is not the only reason. By issuing fresh money we are able to afford to pay back the debts we had, quite simply 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 better to grow because debts are cheap. But what are the consequences of all this? It’s hard to store wealth. So if you keep 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% per 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 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 would be caused by a rise of value of money. To begin with, it could hurt spending as consumers will be incentivised to save lots of 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’ll 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 probably the most is DEBT!!. In a deflationary environment debt can be a real burden as 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 in summary, inflation is growth friendly but is based on debt. Therefore the future generations can pay our debts. Deflation on the other hand makes growth harder nonetheless 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 this fits with bitcoins?
Well, bitcoins are designed 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’ll never have more than 21 million bitcoins around. Therefore they are designed to be deflationary. Now we 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 way to go will be to switch from a debt-based economy to a share-based economy. In fact, because contracting debts in bitcoins will be very costly business can still have the capital they want by issuing shares of these company. This could be a fascinating 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 area of the costs of borrowing capital will 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 a number 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 we inherited from the past generations.