Recently I started buying bitcoins and I’ve heard a great deal of discusses inflation and deflation but not many people actually know and think about 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. Previously it worked quite well because the money that has been issued was associated with gold. So every central bank needed enough gold to pay back all the money it issued. However, in Bitcoin Era Site changed and gold is not 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. For this reason they are printing money, so basically 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 raise 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 might 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’d, basically 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 what are the consequences of all this? It’s hard to store wealth. So if you keep carefully the money (you worked hard to obtain) in your money you’re actually losing wealth because your money is de-valuing pretty quickly.
Because each central bank has an inflation target at around 2% we can well say that keeping money costs all of us at least 2% per year. This discourages savers and spur consumes. This is how 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 our central banks, let’s see why. Basically, we have deflation when overall the prices of goods fall. This would be caused by an increase of value of money. For starters, it could hurt spending as consumers will 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 will lose money as the price they will charge for their 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 can be a real burden as it will only get bigger over time. 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 based on debt. Which means future generations will 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 would 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 will never have a lot 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 easy for businesses to thrive. The way to go will be to switch from the debt-based economy to a share-based economy. Actually, because contracting debts in bitcoins will be very costly business can still have the capital they want by issuing shares of their company. This could be a fascinating 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 portion of the costs of borrowing capital will 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 might buffer a few 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.