Recently I started buying bitcoins and I’ve heard a great deal 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 take action would be to link it with money. In past times it worked quite well as the money that was issued was associated with gold. So every central bank needed enough gold to cover back all of the money it issued. However, in past times century this changed and gold isn’t what’s 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 are not renouncing to do so. That is why they are printing money, so in other words 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 has to raise 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 so? 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 this is true. However, that is not the only reason. By issuing fresh money we can afford to pay 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 is why our countries love inflation. In inflationary environments it’s simpler 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’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 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 costs 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 money because their value increase overtime. On the other hand merchants will undoubtedly be under constant pressure. They will 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 usually 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 since it will only get bigger as time passes. Because our economies derive from debt you can imagine exactly what will be the consequences of deflation.
So to summarize, inflation is growth friendly but is founded on debt. Which means future generations will pay our debts. Deflation however makes growth harder but it implies that future generations won’t have much debt to pay (in such context it will be possible to afford slow growth).
OK so how all of this fits with bitcoins?
Well, bitcoins are designed to be an alternative for the money also to be both a store of value and a mean for trading goods. They are limited in number and we’ll never have more than 21 million bitcoins around. Therefore they are designed to be deflationary. Now Bitcoin Revolution 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 ideal solution will be to switch from a 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 want by issuing shares of their company. This could be a fascinating alternative as it will offer you many investment opportunities and the wealth generated will undoubtedly 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 would be extremely low and there will not be intermediaries between transactions (banks rip people off, both borrowers and lenders). This might 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.