Recently I started buying bitcoins and I’ve heard a lot of discusses inflation and deflation however, not lots of people actually know and consider what inflation and deflation are. But let’s focus on inflation.
We always needed a way to trade value and the most practical way to take action would be to link it with money. Previously it worked quite well as 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, before 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. Because of this they’re printing money, so put simply they’re “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 is worth less, whoever is selling something must 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 offer you is that by de-valuing their currency they are helping the exports.
In fairness, in our global economy that is true. However, that’s not the only real reason. By issuing fresh money we can afford to pay back the debts we’d, in other words we make new debts to cover 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 easier 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 obtain) 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 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, predicated on inflation and debts.
What about deflation? Well this is often the opposite of inflation and 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 an increase of value of money. To begin with, it could hurt spending as consumers will be incentivised to save money because their value increase overtime. However merchants will undoubtedly be under constant pressure. They’ll have to sell their goods quick otherwise they’ll 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 can be a real burden since 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 in summary, inflation is growth friendly but is founded on debt. Therefore the future generations will pay our debts. Bitcoin Evolution makes growth harder nonetheless it implies that future generations won’t have much debt to cover (in such context it might be possible to afford slow growth).
OK so how all this fits with bitcoins?
Well, bitcoins are designed to be an alternative for the money and 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 are designed to be deflationary. We now have all seen what the results 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 will be very expensive business can still obtain the capital they need by issuing shares of their company. This could be a fascinating alternative as it will offer many investment opportunities and the wealth generated will be distributed more evenly among people. However, simply for clarity, I must say that part of the costs of borrowing capital will undoubtedly 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 days gone by generations.