Recently I started buying bitcoins and I’ve heard a lot of talks about inflation and deflation however, not lots of people actually know and think about 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. Previously it worked quite well as the money that has been issued was linked to gold. So every central bank had to have 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 an easy task 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 put simply they’re “creating wealth” out of nothing without really having it. This technique not only 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 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 give 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 reason. By issuing fresh money we can afford to pay back the debts we had, in other words 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. If you keep carefully the money (you worked hard to obtain) 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 can well say that keeping money costs all of us at least 2% per year. This 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 understand why. Basically, we’ve deflation when overall the prices of goods fall. This would be caused by a rise of value of money. For starters, it would hurt spending as consumers will undoubtedly be incentivised to save lots of money because their value will increase overtime. However merchants will be under constant pressure. They’ll have 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 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 since it will only get bigger over time. Because our economies derive from debt you can imagine what will function as consequences of deflation.
So to conclude, inflation is growth friendly but is based on debt. Which means future generations will pay our debts. Deflation alternatively makes growth harder nonetheless it implies 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 money also to be both a store of value and a mean for trading goods. They are limited in number and we’ll never have a lot more than 21 million bitcoins around. Therefore Bitcoin Era Site 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 possible 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 will be very expensive business can still obtain the capital they want by issuing shares of their 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 must say that section 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 number 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 days gone by generations.