Recently I started buying bitcoins and I’ve heard a lot of discusses inflation and deflation however, not lots of people actually know and consider what inflation and deflation are. But let’s start with 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 has been issued was associated with gold. So every central bank had to have enough gold to pay back all of the money it issued. However, during Bitcoin Era Site changed and gold isn’t 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’re printing money, so put simply 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 is worth less, whoever is selling something has to raise the price of goods to reflect their real value, this is called inflation. But what’s behind the amount of money printing? Why are central banks doing this? 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 that is true. However, that is 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 are 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 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 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% each year. This discourages savers and spur consumes. This is one way 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 our central banks, let’s understand why. Basically, we have deflation when overall the prices of goods fall. This would be caused by an increase of value of money. Firstly, it would hurt spending as consumers will undoubtedly be incentivised to save lots of money because their value increase overtime. Alternatively merchants will be under constant pressure. They will need to sell their goods quick otherwise they will lose money because the price they will charge because of their services will drop over time. But when there is something we learned in these years is that central banks and governments usually 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 derive from debt you can imagine what will be the consequences of deflation.
So to conclude, inflation is growth friendly but is based on debt. Therefore the future generations will pay our debts. Deflation alternatively makes growth harder but 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 this fits with bitcoins?
Well, bitcoins are made to be an alternative for the money and 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. Now we have all seen what the consequences of deflation are. However, in a bitcoin-based future it would still be possible for businesses to thrive. The ideal solution will be to switch from a debt-based economy to a share-based economy. Actually, because contracting debts in bitcoins will be very expensive business can still have the capital they need by issuing shares of their 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, just for clarity, I have to say that part of the 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 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 people inherited from the past generations.