Recently I started investing in bitcoins and I’ve heard a lot of talks about inflation and deflation however, not many people actually know and think about 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 was issued was associated with gold. So every central bank needed enough gold to cover back all of the money it issued. However, in past times century this changed and gold is not what’s giving value to money but promises. As possible guess it’s very easy to abuse to such power and certainly the major central banks are not renouncing to do so. Because of this they are printing money, so basically they’re “creating wealth” out of thin air 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 must raise the price of goods to reflect their real value, this is called inflation. But what’s behind the amount of money printing? Why are central banks doing this? Well the answer they would offer you is that by de-valuing their currency they are helping the exports.
In fairness, 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, put simply 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 what are the consequences of all this? It’s hard to store wealth. 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 has an inflation target at around 2% we can 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 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. Firstly, it could 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 will need to sell their goods quick otherwise they will lose money as the price they will charge for their services will drop as time passes. 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 probably the most is DEBT!!. In a deflationary environment debt can be a real burden as 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 in summary, inflation is growth friendly but is based on debt. Which means future generations can pay our debts. Deflation alternatively makes growth harder but it implies that future generations won’t have much debt to pay (in such context it will be possible to cover slow growth).
OK so how all of this fits with bitcoins?
Well, Bitcoin Era 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 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 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 would be very costly business can still obtain the capital they need by issuing shares of these company. This could be an interesting 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 have to say that part of the costs of borrowing capital will undoubtedly be reduced under bitcoins as the fees will 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.