Recently I started buying bitcoins and I’ve heard a great deal of talks about inflation and deflation however, not lots of people actually know and think about what inflation and deflation are. But let’s focus on inflation.
We always needed a way to trade value and the most practical way to do it is to link it with money. During the past it worked quite well as 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, previously century this changed and gold isn’t what is giving value to money but promises. As Click here 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 quite simply they’re “creating wealth” out of thin air 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 increase 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 this? Well the answer they might offer 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 real reason. By issuing fresh money we can afford to cover back the debts we’d, put simply we make new debts to cover 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 which are the consequences of all this? It’s hard to store wealth. So if you keep the money (you worked hard to obtain) in your money you’re 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, predicated 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’ve deflation when overall the prices of goods fall. This might be caused by a rise of value of money. For starters, it could hurt spending as consumers will be incentivised to save lots of money because their value will increase overtime. Alternatively merchants will 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 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 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 function as consequences of deflation.
So to conclude, inflation is growth friendly but is founded on debt. Which means future generations can pay our debts. Deflation however makes growth harder but 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 the 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 they’re 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 ideal solution will be to switch from the debt-based economy to a share-based economy. Actually, because contracting debts in bitcoins will be very costly 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 undoubtedly be distributed more evenly among people. However, simply for clarity, I must say that part of the 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 might 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 we inherited from the past generations.