Recently I started buying bitcoins and I’ve heard a lot of discusses inflation and deflation but not lots of people actually know and think about what inflation and deflation are. But let’s start with inflation.
We always needed ways to trade value and probably 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 needed enough gold to cover back all the money it issued. However, during the past century this changed and gold isn’t what’s giving value to money but promises. Since you can guess it’s very easy to abuse to such power and certainly the major central banks are not renouncing to do so. For this reason they are printing money, so put simply they are “creating wealth” out of thin air without really having it. This process not merely exposes us to risks of economic collapse but 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, inside our global economy that is true. However, that’s not the only reason. By issuing fresh money we are able to afford to cover back the debts we’d, quite simply we make new debts to pay 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 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 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 how our economies are working, based 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 have deflation when overall the prices of goods fall. This might be caused by a rise of value of money. Firstly, it could hurt spending as consumers will undoubtedly be incentivised to save lots of money because their value will increase overtime. However merchants will undoubtedly be under constant pressure. They will have to sell their goods quick otherwise they will lose money as the price they will charge for their services will drop as time passes. 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 as it will only get bigger as time passes. Because our economies derive from debt you can imagine what will be the consequences of deflation.
So to conclude, inflation is growth friendly but is founded on debt. Therefore the future generations can pay our debts. Bitcoin Revolution makes growth harder nonetheless it implies that future generations won’t have much debt to pay (in such context it could be possible to cover slow growth).
OK so how all 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. They are limited in number and we will never have a lot 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 could still be possible for businesses to thrive. The way to go will be to switch from a debt-based economy to a share-based economy. In fact, because contracting debts in bitcoins would be very expensive business can still have the capital they need by issuing shares of their 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 section 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 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 days gone by generations.