Recently I started buying bitcoins and I’ve heard a lot of talks about 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 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 of the money it issued. However, in the past century this changed and gold isn’t what is giving value to money but promises. As possible 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 are printing money, so put simply they are “creating wealth” out of thin air without really having it. This technique 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 must increase 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 might give you is that by de-valuing their currency they are helping the exports.
In fairness, inside our global economy this is true. However, that’s not the only real reason. By issuing fresh money we are able to afford to pay back the debts we’d, basically 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’s why our countries love inflation. In inflationary environments it’s simpler to grow because debts are cheap. But what are the consequences of most this? It’s hard to store wealth. 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 comes with an inflation target at around 2% we are able to well say that keeping money costs all of us at least 2% each 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 the central banks, let’s understand why. Basically, we have deflation when overall the costs of goods fall. This might 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. Alternatively merchants will be under constant pressure. They’ll have to sell their goods quick otherwise they will lose money as 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 probably the most is DEBT!!. In coincapcentral will become a real burden as it will only get bigger as time passes. Because our economies derive from debt you can imagine exactly what will be the consequences of deflation.
So to conclude, inflation is growth friendly but is based on debt. Therefore the future generations will pay our debts. Deflation on the other hand makes growth harder but it means 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 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 are designed to be deflationary. Now we 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. In fact, 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 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 because the fees would be extremely low and there won’t be intermediaries between transactions (banks rip people off, both borrowers and lenders). This might buffer some 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 people inherited from days gone by generations.