Recently I started investing in bitcoins and I’ve heard a great deal of discusses inflation and deflation however, not many people actually know and think about what inflation and deflation are. But let’s start with inflation.
We always needed a method to trade value and probably the most practical way to do it is to link it with money. During the past 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, during the past century this changed and gold is not what is 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 aren’t renouncing to do so. For this reason they’re printing money, so put simply 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 is worth less, whoever is selling something has to increase 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 would offer you is that by de-valuing their currency they’re helping the exports.
In fairness, inside our global economy this is true. However, that is not the only real reason. By issuing fresh money we are able to afford to pay back the debts we had, quite 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 easier to grow because debts are cheap. But which are the consequences of most this? It’s hard to store wealth. If you keep the money (you worked hard to get) in your bank account you are 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% each 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 and it is the biggest nightmare for our 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 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 have to sell their goods quick otherwise they’ll lose money as the price they will charge for their 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 will become a real burden as it will only get bigger over time. Because our economies are based on debt you can imagine what will be the consequences of deflation.
So in summary, inflation is growth friendly but is based on debt. Which means 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 will be possible to cover slow growth).
OK so how all of 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’re limited in number and we’ll never have a lot more than 21 million bitcoins around. Therefore they’re designed to be deflationary. Now we have all seen what the results 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 the debt-based economy to a share-based economy. Actually, because contracting coincapcentral in bitcoins would be very costly business can still have the capital they want 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 must say that the main costs of borrowing capital will undoubtedly be reduced under bitcoins because 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 pay back the huge debts that we inherited from days gone by generations.