Recently I started buying bitcoins and I’ve heard a great deal of discusses inflation and deflation but 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 probably 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 past times century this changed and gold isn’t what’s giving value to money but promises. As you can guess it’s very an easy task to abuse to such power and certainly the major central banks aren’t renouncing to do so. For this reason they’re printing money, so in other words they are “creating wealth” out of nothing without really having it. This technique 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 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 might give you is that by de-valuing their currency they’re helping the exports.
In fairness, inside our global economy this is true. However, that’s not the only reason. By issuing fresh money we are able to afford to pay 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 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 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 bank account 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 are able to 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 in fact it is the biggest nightmare for our central banks, let’s understand why. Basically, we’ve deflation when overall the prices of goods fall. This would be caused by an increase of value of money. To begin with, it would hurt spending as consumers will be incentivised to save money because their value will increase overtime. On the other hand merchants will undoubtedly be under constant pressure. They’ll need to sell their goods quick otherwise they’ll lose money because the price they will charge for his or her 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 probably the most is DEBT!!. In a deflationary environment debt can be a real burden as it will only get bigger over time. Because our economies derive from debt you can imagine exactly what will be the consequences of deflation.
So to conclude, inflation is growth friendly but is founded on debt. Which means future generations will pay our debts. Deflation however makes growth harder but it means that future generations won’t have much debt to pay (in such context it could be possible to cover slow growth).
OK so how all this fits with bitcoins?
Well, bitcoins are made to be an alternative for money and to be both a store of value and a mean for trading goods. They’re limited in number and we will 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 could still be easy for businesses to thrive. coincapcentral to go will be to switch from a debt-based economy to a share-based economy. Actually, because contracting debts in bitcoins would be very expensive business can still have the capital they want by issuing shares of these company. This could be an interesting 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 undoubtedly 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 a few 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.