Recently I started investing in bitcoins and I’ve heard a great deal of talks about inflation and deflation but not lots of people actually know and consider what inflation and deflation are. But let’s start with inflation.
We always needed a method to trade value and the most practical way to take action would be 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 the money it issued. However, during the past century this changed and gold isn’t 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 basically they’re “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 is 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 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 this is true. However, that is coincapcentral . By issuing fresh money we can afford to pay back the debts we’d, in other words 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’s why our countries love inflation. In inflationary environments it’s simpler to grow because debts are cheap. But which are the consequences of most this? It’s hard to store wealth. If you keep carefully the money (you worked hard to get) in your bank account you’re actually losing wealth because your cash is de-valuing pretty quickly.
Because each central bank comes with an inflation target at around 2% we are able to well say that keeping money costs all 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 exactly the opposite of inflation in fact it is the biggest nightmare for the central banks, let’s see why. Basically, we have deflation when overall the costs of goods fall. This would be caused by an increase of value of money. First of all, it would 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 because 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 do not care much about consumers or merchants, what they care probably the most is DEBT!!. In a deflationary environment debt will become a real burden since it will only get bigger over time. Because our economies are based on debt you can imagine exactly what will be the consequences of deflation.
So to conclude, inflation is growth friendly but is founded on debt. Therefore the 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 this fits with bitcoins?
Well, bitcoins are designed to be an alternative for 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’re designed to be deflationary. Now we 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 obtain the capital they need by issuing shares of these company. This could be a fascinating alternative as it will offer many investment opportunities and the wealth generated will undoubtedly be distributed more evenly among people. However, just for clarity, I must say that the main costs of borrowing capital will undoubtedly be reduced under bitcoins as the fees would be extremely low and there won’t be intermediaries between transactions (banks rip people off, both borrowers and lenders). This might buffer some 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.