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 focus on inflation.
We always needed a way to trade value and the most practical way to take action is to link it with money. During the past 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 of the money it issued. However, previously century this changed and gold isn’t what’s giving value to money but promises. Since you can guess it’s very easy to abuse to such power and certainly the major central banks are not renouncing to do so. That is why they’re printing money, so quite simply they are “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 must 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 might give 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 fresh money we can afford to cover back the debts we’d, put simply 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 money 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 most of us at least 2% per 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 often 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 would be caused by a rise of value of money. To begin with, it could hurt spending as consumers will be incentivised to save 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 as the price they will charge for his or her 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 as it will only get bigger over time. Because our economies are based on debt you can imagine exactly what will be the consequences of deflation.
So to summarize, inflation is growth friendly but is founded on debt. Therefore the future generations can 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 cover 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’re limited in number and we will never have more than 21 million bitcoins around. Therefore they are 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 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 want by issuing shares of their company. Bitcoin Era could be a fascinating 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 must say that the main costs of borrowing capital will be reduced under bitcoins because the fees would be extremely low and there won’t 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 pay back the huge debts that people inherited from the past generations.