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 way 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 as the money that was issued was linked to gold. So every central bank had to have enough gold to pay back all the money it issued. However, during the past 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. That is why they’re printing money, so in other words 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 money printing? Why are central banks doing so? 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 that is true. However, that’s not the only real reason. By issuing Bitcoin Era can afford to pay back the debts we had, in other words 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 better to grow because debts are cheap. But which are the consequences of all this? It’s hard to store wealth. So if you keep carefully the money (you worked hard to obtain) 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 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 have deflation when overall the costs of goods fall. This would be caused by a rise of value of money. For starters, it could hurt spending as consumers will undoubtedly be incentivised to save money because their value increase overtime. Alternatively 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 because of their services will drop over time. But if 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 are based on debt you can imagine what will function as consequences of deflation.
So to conclude, inflation is growth friendly but is based on debt. Which means future generations will pay our debts. Deflation however makes growth harder but it means that future generations won’t have much debt to pay (in such context it will be possible to afford slow growth).
OK so how all 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 will 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 easy for businesses to thrive. The ideal solution 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 their company. This could be a fascinating 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 part of the costs of borrowing capital will be reduced under bitcoins because the fees will be extremely low and there will not be intermediaries between transactions (banks rip people off, both borrowers and lenders). This would 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.