Recently I started buying 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’ coincapcentral with inflation.
We always needed a way to trade value and the most practical way to do it would be to link it with money. Before it worked quite well because the money that was issued was linked to gold. So every central bank had to have enough gold to cover back all of the money it issued. However, before century this changed and gold is not what’s giving value to money but promises. Since you can guess it’s very an easy task to abuse to such power and certainly the major central banks are not renouncing to do so. That is why they’re printing money, so in other words they are “creating wealth” out of nothing 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, that is called inflation. But what’s behind the money printing? Why are central banks doing this? Well the answer they 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 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 pay the old ones. But that is not only it, by de-valuing our currencies we are 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 what 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 bank account 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 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 the central banks, let’s see why. Basically, we’ve deflation when overall the prices of goods fall. This would be caused by an increase of value of money. For starters, it would hurt spending as consumers will be incentivised to save lots of money because their value increase overtime. However merchants will be under constant pressure. They will need to sell their goods quick otherwise they will lose money as the price they will charge for their services will drop over time. 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 probably 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 are based on debt you can imagine what will function as consequences of deflation.
So to summarize, inflation is growth friendly but is founded on debt. Therefore the future generations will pay our debts. Deflation on the other hand 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 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 more than 21 million bitcoins around. Therefore they’re 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 easy 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 would be very costly business can still obtain the capital they want by issuing shares of these company. This could be a fascinating 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 portion of the costs of borrowing capital will be reduced under bitcoins because the fees would be extremely low and there will not 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 pay back the huge debts that we inherited from days gone by generations.