Recently I started buying bitcoins and I’ve heard a great deal of discusses inflation and deflation however, not lots of people actually know and think about what inflation and deflation are. But let’s start with inflation.
We always needed a way to trade value and the most practical way to take action is to link it with money. In the past it worked quite well because the money that has been issued was associated with gold. So every central bank had to have enough gold to pay back all of the money it issued. However, previously century this changed and gold isn’t what is giving value to money but promises. As you can guess it’s very an easy task to abuse to such power and certainly the major central banks aren’t renouncing to do so. For this reason they’re printing money, so put simply they are “creating wealth” out of thin air without really having it. This process 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 has to 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 would give you is that by de-valuing their currency they are 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 can afford to cover back the debts we’d, quite 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 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. If you keep carefully the money (you worked hard to get) in your bank account 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 can 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, predicated on inflation and debts.
What about deflation? Well this is exactly the opposite of inflation and it is the biggest nightmare for our central banks, let’s understand why. Basically, we have deflation when overall the prices of goods fall. This might be caused by a rise of value of money. To begin with, Bitcoin Revolution could hurt spending as consumers will be incentivised to save money because their value will increase overtime. On the other hand merchants will be under constant pressure. They will need to sell their goods quick otherwise they will lose money as the price they will charge for his or her services will drop as time passes. But when 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 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 be the consequences of deflation.
So to conclude, inflation is growth friendly but is founded on debt. Which means future generations can pay our debts. Deflation however makes growth harder but it means that future generations won’t have much debt to cover (in such context it could be possible to cover slow growth).
OK so how all 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’ll never have 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 a bitcoin-based future it could still be possible for businesses to thrive. The way to go will be to switch from the debt-based economy to a share-based economy. In fact, because contracting debts in bitcoins will be very costly business can still obtain the capital they need by issuing shares of these 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 part of the costs of borrowing capital will be reduced under bitcoins because 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 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 days gone by generations.