Recently I started investing in bitcoins and I’ve heard a lot of discusses inflation and deflation however, not many people actually know and consider what inflation and deflation are. But let’s start with inflation.
We always needed ways to trade value and the most practical way to do it would be to link it with money. During the past it worked quite well because the money that was issued was associated with gold. So every central bank needed 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. Since you can guess it’s very an easy task 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 quite simply they’re “creating wealth” out of thin air without really having it. This technique not only 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, this is called inflation. But what’s behind the amount of 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, in our global economy that is true. However, that’s not the only real reason. By issuing fresh money we are able to afford to cover back the debts we had, put simply we make new debts to pay the old ones. But that is 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 easier to grow because debts are cheap. But which are the consequences of most this? It’s hard to store wealth. If you keep 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 has 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 often the opposite of inflation and it is the biggest nightmare for our central banks, let’s see why. Basically, we have deflation when overall the costs of goods fall. This might be caused by an increase of value of money. Firstly, coincapcentral could hurt spending as consumers will undoubtedly be incentivised to save lots of money because their value will increase overtime. On the other hand merchants will be under constant pressure. They will have to sell their goods quick otherwise they will lose money because the price they will charge because of 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 exactly what will function as consequences of deflation.
So to summarize, inflation is growth friendly but is founded on debt. Which means future generations will pay our debts. Deflation alternatively 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 of this fits with bitcoins?
Well, bitcoins are made to be an alternative for the money and to be both a store of value and a mean for trading goods. They’re limited in number and we will never have a lot more than 21 million bitcoins around. Therefore they’re 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 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 obtain the capital they need 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 the main 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 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.