Recently I started investing in bitcoins and I’ve heard a great deal 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.
We always needed a method to trade value and probably the most practical way to do it is to link it with money. Before it worked quite well as the money that was issued was linked to 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 is not what’s giving value to money but promises. As you can guess it’s very easy to abuse to such power and certainly the major central banks aren’t renouncing to do so. For this reason they are printing money, so put simply they’re “creating wealth” out of nothing without really having it. This technique not merely 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 amount of 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 that is true. However, that is not the only reason. By issuing fresh money we are able to afford to cover back the debts we’d, basically 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 which are the consequences of all this? It’s hard to store wealth. So if you keep the money (you worked hard to obtain) 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 how our economies are working, based on inflation and debts.
What about deflation? Well this is often the opposite of inflation and 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 a rise of value of money. First of all, it could hurt spending as consumers will undoubtedly be incentivised to save lots of money because their value will 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 because the price they will charge because of their services will drop as time passes. But if 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 since it will only get bigger over time. Because our economies derive from debt you can imagine what will function as consequences of deflation.
So to summarize, inflation is growth friendly but is based on debt. Which means 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 would be possible to afford slow growth).
OK so how all of this fits with bitcoins?
Well, bitcoins are made to be an alternative for money and to be both a store of value and a mean for trading goods. They are limited in number and we will 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 easy for businesses to thrive. Bitcoin Era Site will be to switch from a debt-based economy to a share-based economy. In fact, 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 an interesting alternative as it will offer many investment opportunities and the wealth generated will be distributed more evenly among people. However, just for clarity, I must say that portion 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 might buffer a number 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 days gone by generations.