Recently I started investing in bitcoins and I’ve heard a lot of talks about inflation and deflation however, not many people actually know and consider what inflation and deflation are. But let’s focus on inflation.
We always needed ways to trade value and probably the most practical way to take action would be to link it with money. In the past it worked quite well as the money that has been issued was associated with gold. So every central bank needed enough gold to pay back all of the money it issued. However, in past times century this changed and gold is not 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 aren’t renouncing to do so. For this reason they’re printing money, so in other words they’re “creating wealth” out of nothing 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 increase 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 this? Well the answer they might give you is that by de-valuing their currency they are helping the exports.
In fairness, in our global economy this is true. However, that’s Bitcoin Era Official . By issuing fresh money we are able to 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 is why our countries love inflation. In inflationary environments it’s simpler 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 money is de-valuing pretty quickly.
Because each central bank has an inflation target at around 2% we can well say that keeping money costs all of us at least 2% per year. This discourages savers and spur consumes. This is one way 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 understand why. Basically, we’ve deflation when overall the costs of goods fall. This would be caused by an increase of value of money. To begin with, it would hurt spending as consumers will be incentivised to save money because their value will increase overtime. Alternatively merchants will undoubtedly be under constant pressure. They will have to sell their goods quick otherwise they’ll lose money because the price they will charge for his or her services will drop over time. 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 can be a real burden as it will only get bigger as time passes. Because our economies derive from debt you can imagine what will function as consequences of deflation.
So to summarize, inflation is growth friendly but is founded on debt. Which means future generations will pay our debts. Deflation alternatively makes growth harder but it means that future generations won’t have much debt to pay (in such context it would 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 also to be both a store of value and a mean for trading goods. They’re limited in number and we’ll never have 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 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. In fact, because contracting debts in bitcoins would be very costly business can still obtain 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, simply for clarity, I have to say that the main costs of borrowing capital will be reduced under bitcoins as 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 cover back the huge debts that we inherited from the past generations.