Recently I started investing in bitcoins and I’ve heard a lot of talks about inflation and deflation but not lots of 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 probably the most practical way to do it would be to link it with money. During the past it worked quite well as the money that has been issued was linked to gold. So every central bank had to have enough gold to pay back all of 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. Because of this they are printing money, so in other words they are “creating wealth” out of nothing without really having it. This technique not only 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 coincapcentral 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 is not the only reason. By issuing fresh money we are able to afford to pay back the debts we’d, basically we make new debts to cover 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. If you keep the money (you worked hard to get) in your money you are actually losing wealth because your cash is de-valuing pretty quickly.
Because each central bank comes with an inflation target at around 2% we are able to well say that keeping money costs all of us at least 2% each 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 understand why. Basically, we’ve deflation when overall the prices of goods fall. This might be caused by a rise of value of money. Firstly, it could hurt spending as consumers will undoubtedly be incentivised to save 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 as time passes. 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 are based on debt you can imagine exactly what will function as consequences of deflation.
So to summarize, inflation is growth friendly but is founded on debt. Therefore the future generations can pay our debts. Deflation however 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 this fits with bitcoins?
Well, bitcoins are made to be an alternative for the 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 would still be easy 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, just for clarity, I have to say that section of the costs of borrowing capital will undoubtedly 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 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.