Recently Bitcoin Era Site started investing in bitcoins and I’ve heard a great deal of talks about inflation and deflation however, not many people actually know and think about what inflation and deflation are. But let’s focus on inflation.
We always needed a method to trade value and probably the most practical way to do it would be to link it with money. In the past it worked quite well because the money that has been issued was linked to gold. So every central bank needed 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 quite simply they are “creating wealth” out of thin air without really having it. This process 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 must raise 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 so? Well the answer they would offer you is that by de-valuing their currency they are helping the exports.
In fairness, in our global economy this 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 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 get) in your money 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 can well say that keeping money costs most of us at least 2% per year. This discourages savers and spur consumes. This is how 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 see why. Basically, we have deflation when overall the costs 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 money because their value will increase overtime. However 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 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 the most is DEBT!!. In a deflationary environment debt will become 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 in summary, inflation is growth friendly but is founded on debt. Therefore the future generations will pay our debts. Deflation however makes growth harder nonetheless it implies that future generations won’t have much debt to cover (in such context it could be possible to cover slow growth).
OK so how all 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’re limited in number and we will 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 easy for businesses to thrive. The ideal solution will be to switch from a debt-based economy to a share-based economy. Actually, because contracting debts in bitcoins will be very costly 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 undoubtedly be distributed more evenly among people. However, just for clarity, I have to say that the main costs of borrowing capital will undoubtedly be reduced under bitcoins as the fees would 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 people inherited from the past generations.