Recently I started buying bitcoins and I’ve heard a lot of discusses inflation and deflation but not lots of people actually know and consider what inflation and deflation are. But let’s focus on inflation.
We always needed a way to trade value and probably the most practical way to do it 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 had to have enough gold to cover back all of the money it issued. However, in 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. That is why they are printing money, so basically they are “creating wealth” out of nothing without really having it. This process 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 raise 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 would give you is that by de-valuing their currency they’re helping the exports.
In fairness, in our global economy this is true. However, that’s not the only real reason. By issuing fresh money we are able to afford to cover back the debts we’d, basically we make new debts to cover 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 which are the consequences of most this? It’s hard to store wealth. So if you keep carefully the money (you worked hard to get) in your bank account you’re actually losing wealth because your money is de-valuing pretty quickly.
Because each central bank has 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 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 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 would hurt spending as consumers will be incentivised to save lots of money because their value will increase overtime. However merchants will undoubtedly be under constant pressure. They’ll need to sell their goods quick otherwise they’ll lose money as the price they will charge because of 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 since it will only get bigger as time passes. Because our economies derive from debt you can imagine exactly what will function as consequences of deflation.
So to conclude, inflation is growth friendly but is based on debt. Therefore the future generations will pay our debts. Deflation however makes growth harder but it means that future generations won’t have much debt to cover (in such context it could be possible to afford slow growth).
OK so how all of this fits with bitcoins?
Well, bitcoins are made to be an alternative for the money and to be both a store of value and a mean for trading goods. They’re limited in number and we’ll never have a lot more than 21 million bitcoins around. Therefore they are designed to be deflationary. Now we have all seen what the consequences of deflation are. However, in a bitcoin-based future it would 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. In fact, because contracting debts in bitcoins will be very expensive business can still have the capital they want 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 undoubtedly be distributed more evenly among people. However, simply for clarity, I must say that the main costs of borrowing capital will undoubtedly 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 would buffer a few of the negative sides of deflation. Nevertheless, bitcoin s will face many problems unfortunately, as governments still need fiat money to pay back the huge debts that people inherited from days gone by generations.