Recently I started buying bitcoins and I’ve heard a lot of talks about 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 ways to trade value and the most practical way to take action is to link it with money. In the past it worked quite well as the money that has been issued was associated with gold. So every central bank needed enough gold to pay back all of the money it issued. However, before century this changed and gold isn’t what’s giving value to money but promises. Since you can guess it’s very easy to abuse to such power and certainly the major central banks are not renouncing to do so. That is why they are printing money, so quite simply they are “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 is worth less, whoever is selling something has to increase the price of goods to reflect their real value, this is called inflation. But what’s behind the money printing? Why are central banks doing this? Well technical analysis might give you is that by de-valuing their currency they’re helping the exports.
In fairness, in 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, 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 simpler to grow because debts are cheap. But which are the consequences of most this? It’s hard to store wealth. If you keep the money (you worked hard to get) in your bank account you’re actually losing wealth because your cash 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, predicated on inflation and debts.
What about deflation? Well this is exactly the opposite of inflation in fact it is the biggest nightmare for our central banks, let’s see why. Basically, we have deflation when overall the prices of goods fall. This would be caused by a rise of value of money. Firstly, it could hurt spending as consumers will undoubtedly be incentivised to save lots of 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 will lose money because the price they will charge because of their services will drop as time passes. 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 since 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 summarize, inflation is growth friendly but is based on debt. Therefore the future generations can pay our debts. Deflation on the other hand makes growth harder nonetheless it implies that future generations won’t have much debt to pay (in such context it would be possible to cover slow growth).
OK so how all this fits with bitcoins?
Well, bitcoins are made to be an alternative for 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 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. In fact, because contracting debts in bitcoins would be very costly business can still have the capital they need 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, just for clarity, I must say that the main costs of borrowing capital will undoubtedly be reduced under bitcoins as the fees will 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 cover back the huge debts that we inherited from the past generations.