Recently I started buying bitcoins and I’ve heard a great deal of discusses inflation and deflation however, not many 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 the most practical way to do it is to link it with money. Before it worked quite well because the money that was issued was associated with gold. So every central bank needed enough gold to pay back all of the money it issued. However, in past times century this changed and gold isn’t 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 aren’t renouncing to do so. For this reason they are printing money, so basically they’re “creating wealth” out of nothing without really having it. This process not only 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 amount of money printing? Why are central banks doing so? Well the answer they would give you is that by de-valuing their currency they are helping the exports.
In fairness, inside our global economy that is true. However, that’s not the only real reason. By issuing fresh money we can afford to cover back the debts we’d, in other words 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 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 money 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 can well say that keeping money costs all of us at least 2% each year. This discourages savers and spur consumes. This is how 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 the central banks, let’s understand why. Basically, we have deflation when overall the prices of goods fall. This might be caused by an increase of value of money. To start with, it would hurt spending as consumers will be incentivised to save lots of money because their value increase overtime. Alternatively merchants will be under constant pressure. They’ll have to sell their goods quick otherwise they will lose money because the price they will charge for their services will drop as time passes. 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 probably 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 in summary, inflation is growth friendly but is based 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 could be possible to afford slow growth).
OK so how all this fits with bitcoins?
Well, bitcoins are designed to be an alternative for the money and to be both a store of value and a mean for trading goods. They are limited in number and we will never have 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 Bitcoin Era Official -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 will be very costly business can still have the capital they need 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 be distributed more evenly among people. However, simply for clarity, I must say that portion of the costs of borrowing capital will undoubtedly be reduced under bitcoins as the fees would 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 we inherited from the past generations.