Recently I started investing in bitcoins and I’ve heard a great deal of talks about inflation and deflation but not many people actually know and consider what inflation and deflation are. But let’s start with inflation.
We always needed a method to trade value and the most practical way to take action is to link it with money. In the past it worked quite well because the money that has been issued was associated with 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 is giving value to money but promises. As you can guess it’s very an easy task to abuse to such power and certainly the major central banks aren’t renouncing to do so. For this reason they’re printing money, so quite simply they’re “creating wealth” out of thin air without really having it. This technique not only 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, this is called inflation. But what’s behind the amount of money printing? Why are central banks doing so? Well the answer they might offer you is that by de-valuing their currency they are helping the exports.
In coincapcentral , in our global economy that is true. However, that’s not the only reason. By issuing fresh money we can afford to pay back the debts we’d, basically 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 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 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 has an inflation target at around 2% we are able to well say that keeping money costs most of us at least 2% per 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 in fact 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. To begin with, it could hurt spending as consumers will undoubtedly be incentivised to save money because their value will increase overtime. On the other hand 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 their services will drop as time passes. But if 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 probably the most is DEBT!!. In a deflationary environment debt can be 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 summarize, inflation is growth friendly but is founded on debt. Therefore the future generations can pay our debts. Deflation alternatively 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 of this fits with bitcoins?
Well, bitcoins are made to be an alternative for money and 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 are designed to be deflationary. We now 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 have the capital they need by issuing shares of these company. This could be an interesting alternative as it will offer you many investment opportunities and the wealth generated will be distributed more evenly among people. However, simply for clarity, I must say that area of the costs of borrowing capital will 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 few 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.