Recently I started investing in bitcoins and I’ve heard a great deal of talks about inflation and deflation but not many 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 do it would be to link it with money. In past times it worked quite well because the money that has been issued was associated with gold. So every central bank needed enough gold to cover back all of the money it issued. However, before century this changed and gold is not what is 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. Because of this they’re printing money, so quite simply they’re “creating wealth” out of nothing without really having it. This process not merely 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 increase 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 would give you is that by de-valuing their currency they’re helping the exports.
In Bitcoin Era Official , in our global economy this is true. However, that’s not the only reason. By issuing fresh money we can afford to pay back the debts we had, in other words 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 is why our countries love inflation. In inflationary environments it’s easier to grow because debts are cheap. But which are the consequences of most this? It’s hard to store wealth. So if you keep the money (you worked hard to obtain) 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 are able to 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, based 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 see why. Basically, we’ve deflation when overall the costs of goods fall. This might be caused by a rise of value of money. For starters, it could hurt spending as consumers will be incentivised to save lots of 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’ll lose money because the price they will charge for 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 over time. Because our economies derive from debt you can imagine exactly what will be the consequences of deflation.
So to conclude, inflation is growth friendly but is based on debt. Therefore the future generations will pay our debts. Deflation on the other hand makes growth harder nonetheless it means 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 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’ll never have a lot more than 21 million bitcoins around. Therefore they are designed to be deflationary. We now have all seen what the consequences of deflation are. However, in a bitcoin-based future it could still be easy for businesses to thrive. The ideal solution will be to switch from a debt-based economy to a share-based economy. Actually, 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 an interesting 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 have to say that part 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 would 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.