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 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 do it is to link it with money. During the past it worked quite well because the money that was issued was linked to gold. So every central bank had to have enough gold to pay back all the money it issued. However, in the past century this changed and gold isn’t what’s giving value to money but promises. As you can guess it’s very easy 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 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 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 would give you is that by de-valuing their currency they are helping the exports.
In fairness, in 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, basically 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 most this? It’s hard to store wealth. So if you keep 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 has 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, 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’ve deflation when overall the prices of goods fall. This would be caused by a rise of value of money. To start with, it would hurt spending as consumers will undoubtedly be incentivised to save lots of money because their value increase overtime. However merchants will undoubtedly be under constant pressure. They will have 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 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 as time passes. 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 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 cover slow growth).
OK so how all of this fits with bitcoins?
Well, bitcoins are designed to be an alternative for the money also to be both a store of value and a mean for trading goods. Bitcoin Era are limited in number and we’ll never have a lot more than 21 million bitcoins around. Therefore they are designed to be deflationary. We now 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 the 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 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 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 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 we inherited from days gone by generations.