Recently I started investing in bitcoins and I’ve heard a lot of discusses inflation and deflation however, not many people actually know and consider what inflation and deflation are. But let’s focus on inflation.
We always needed a method to trade value and the most practical way to take action is to link it with money. During the past it worked quite well because the money that was issued was associated with gold. So every central bank had to have enough gold to pay back all the money it issued. However, in past times 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. Because of this they’re printing money, so in other words they are “creating wealth” out of thin air without really having it. This process not merely exposes us to risks of economic collapse but 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, that 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 are helping the exports.
In fairness, inside our global economy this is true. However, that is not the only reason. By issuing fresh money we are able to afford to cover back the debts we had, quite simply 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 easier to grow because debts are cheap. But what are the consequences of all this? It’s hard to store wealth. If you keep carefully the money (you worked hard to get) in your bank account you are 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 all 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 the central banks, let’s see why. Basically, we’ve deflation when overall the costs of goods fall. Krogerexperiencee would be caused by a rise of value of money. To begin with, it could 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 because the price they will charge for his or her 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 can be a real burden as 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 founded on debt. Therefore the future generations will pay our debts. Deflation on the other hand makes growth harder nonetheless it implies that future generations won’t have much debt to cover (in such context it could 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 and 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 consequences of deflation are. However, in a bitcoin-based future it would still be possible for businesses to thrive. The way to go 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 a fascinating 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 undoubtedly be reduced under bitcoins as the fees will be extremely low and there will not 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.