Recently I started investing in bitcoins and I’ve heard a lot of discusses inflation and deflation but not many people actually know and think about what inflation and deflation are. But let’s focus on inflation.
Bitcoin Era needed a method to trade value and probably the most practical way to do it would be to link it with money. Before it worked quite well as the money that was issued was associated with gold. So every central bank had to have enough gold to cover back all the money it issued. However, before century this changed and gold isn’t what is giving value to money but promises. Since you can guess it’s very easy to abuse to such power and certainly the major central banks are not renouncing to do so. For this reason they’re printing money, so basically 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 is worth less, whoever is selling something has to increase the price of goods to reflect their real value, this is called inflation. But what’s behind the money printing? Why are central banks doing so? Well the answer they would give you is that by de-valuing their currency they’re helping the exports.
In fairness, inside our global economy this is true. However, that’s not the only reason. By issuing fresh money we are able to afford to pay back the debts we’d, quite simply we make new debts to cover the old ones. But that’s 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 better to grow because debts are cheap. But which are the consequences of all this? It’s hard to store wealth. If you keep the money (you worked hard to get) in your money you are actually losing wealth because your cash is de-valuing pretty quickly.
Because each central bank has an inflation target at around 2% we can well say that keeping money costs most of us at least 2% each year. This discourages savers and spur consumes. This is how our economies are working, predicated on inflation and debts.
What about deflation? Well this is often the opposite of inflation in fact 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 would hurt spending as consumers will undoubtedly be incentivised to save money because their value increase overtime. Alternatively merchants will be under constant pressure. They’ll have to sell their goods quick otherwise they’ll lose money because the price they will charge for his or her services will drop over time. 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 are based on 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 can pay our debts. Deflation on the other hand makes growth harder but it implies that future generations won’t have much debt to cover (in such context it would be possible to afford slow growth).
OK so how all of 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 are 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 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 the debt-based economy to a share-based economy. Actually, because contracting debts in bitcoins would 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 you many investment opportunities and the wealth generated will be distributed more evenly among people. However, just for clarity, I have to say that portion of the costs of borrowing capital will undoubtedly be reduced under bitcoins because 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 a few 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 people inherited from the past generations.