Recently I started buying bitcoins and I’ve heard a great deal of discusses inflation and deflation but not lots of 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 take action would be to link it with money. In past times it worked quite well as the money that has been issued was associated with gold. So every central bank had to have enough gold to cover back all the money it issued. However, in the past century this changed and gold isn’t what is 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 are printing money, so basically 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 is worth less, whoever is selling something must 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, inside our global economy this is true. However, that is not the only real reason. By issuing fresh money we are able to afford to pay back the debts we’d, put simply we make new debts to pay the old ones. But that’s not only it, by de-valuing our currencies we have been de-facto de-valuing our debts. That’s why our countries love inflation. In inflationary environments it’s easier to grow because debts are cheap. But what are the consequences of most this? It’s hard to store wealth. If you keep carefully 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 comes with an inflation target at around 2% we can well say that keeping money costs most of us at least 2% per year. coincapcentral 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 in fact it is the biggest nightmare for the central banks, let’s see why. Basically, we’ve deflation when overall the prices of goods fall. This might be caused by a rise of value of money. To start with, it would hurt spending as consumers will be incentivised to save lots of money because their value will increase overtime. Alternatively merchants will undoubtedly be under constant pressure. They’ll have to sell their goods quick otherwise they will lose money as the price they will charge for their services will drop over time. 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 as it will only get bigger as time passes. Because our economies are based on debt you can imagine what will function as consequences of deflation.
So to summarize, inflation is growth friendly but is founded on debt. Therefore the future generations will pay our debts. Deflation however makes growth harder nonetheless it means that future generations won’t have much debt to pay (in such context it would 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 also to be both a store of value and a mean for trading goods. They’re limited in number and we’ll never have a lot more than 21 million bitcoins around. Therefore they’re designed to be deflationary. We now 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 the debt-based economy to a share-based economy. Actually, because contracting debts in bitcoins would be very costly business can still have the capital they want 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, simply for clarity, I have to 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 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 days gone by generations.