Recently I started investing in bitcoins and I’ve heard a lot of talks about inflation and deflation however, not lots of people actually know and consider what inflation and deflation are. But let’s focus on inflation.
We always needed a method 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 because the money that has been issued was linked to gold. So every central bank had to have enough gold to pay back all of the money it issued. However, during the past 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 aren’t renouncing to do so. Because of this they’re printing money, so quite simply they are “creating wealth” out of thin air without really having it. This technique 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 increase the price of goods to reflect their real value, this is called inflation. But what’s behind the amount of 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 are able to afford to pay back the debts we had, put 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 easier 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 get) 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 most 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 understand why. Basically, we’ve deflation when overall the costs of goods fall. This might be caused by a rise of value of money. Firstly, it could hurt spending as consumers will undoubtedly be incentivised to save money because their value increase overtime. On the other hand merchants will be under constant pressure. They’ll need to sell their goods quick otherwise they will lose money because the price they will charge for their services will drop as time passes. 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 probably 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 conclude, inflation is growth friendly but is based on debt. Therefore the future generations can pay our debts. Deflation however makes growth harder nonetheless it implies that future generations won’t have much debt to cover (in such context it might be possible to afford slow growth).
OK so how all of 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 a lot more than 21 million bitcoins around. Therefore they are designed to be deflationary. We now have all seen what the consequences of deflation are. However, in Bitcoin Era -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. 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 many investment opportunities and the wealth generated will be distributed more evenly among people. However, simply 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 won’t 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 cover back the huge debts that people inherited from the past generations.