Recently I started investing in bitcoins and I’ve heard a great deal of discusses inflation and deflation however, not lots of people actually know and consider what inflation and deflation are. But let’s focus on inflation.
We always needed ways to trade value and probably 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 needed 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 possible 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 are 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 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 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 this is true. However, that’s not the only reason. By issuing fresh money we are able to afford to cover back the debts we’d, quite simply 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 better to grow because debts are cheap. But what are the consequences of most this? It’s hard to store wealth. So if you keep carefully the money (you worked hard to get) in your bank account you’re 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 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 in fact it is the biggest nightmare for the central banks, let’s understand why. Basically, we have deflation when overall the costs of goods fall. This would 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. However merchants will undoubtedly be under constant pressure. They’ll have 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 can be a real burden since 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 based on debt. Therefore the future generations will pay our debts. Bitcoin Era on the other hand makes growth harder nonetheless it means that future generations won’t have much debt to pay (in such context it might be possible to afford slow growth).
OK so how all of this fits with bitcoins?
Well, bitcoins are designed 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 are 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 easy for businesses to thrive. The way to go will be to switch from the debt-based economy to a share-based economy. In fact, because contracting debts in bitcoins would be very expensive business can still have 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 be distributed more evenly among people. However, simply for clarity, I have to say that the main costs of borrowing capital will be reduced under bitcoins because 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 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 we inherited from the past generations.