Recently I started investing in bitcoins and I’ve heard a lot of talks about inflation and deflation however, not many people actually know and think about what inflation and deflation are. But let’s focus on inflation.
Bitcoin Revolution needed a method to trade value and probably the most practical way to take action would be to link it with money. In the past it worked quite well as the money that has been issued was associated with gold. So every central bank had to have enough gold to pay back all the money it issued. However, in the past century this changed and gold is not what is 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 put simply they are “creating wealth” out of nothing without really having it. This process not only exposes us to risks of economic collapse but it results also with the de-valuation of money. Therefore, because money will probably be worth less, whoever is selling something has to increase the price of goods to reflect their real value, that is called inflation. But what’s behind the money printing? Why are central banks doing this? Well the answer they might give 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 real reason. By issuing fresh money we are able to afford to pay back the debts we had, basically 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 simpler to grow because debts are cheap. But what are the consequences of most this? It’s hard to store wealth. If you keep the money (you worked hard to obtain) in your bank account you’re 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 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 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 would be caused by a rise of value of money. Firstly, it 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 have to sell their goods quick otherwise they’ll lose money as the price they will charge for their services will drop over time. 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 will become a real burden as it will only get bigger over time. Because our economies derive from debt you can imagine what will be the consequences of deflation.
So to summarize, inflation is growth friendly but is founded on debt. Which means future generations can pay our debts. Deflation alternatively makes growth harder but it implies that future generations won’t have much debt to pay (in such context it would 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 will never have more than 21 million bitcoins around. Therefore they’re designed to be deflationary. We now 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 expensive business can still have 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, just for clarity, I have to say that area of the costs of borrowing capital will be reduced under bitcoins because the fees will 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 people inherited from the past generations.