Recently I started investing in bitcoins and I’ve heard a great deal of talks about inflation and deflation but not lots of people actually know and think about 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 do it would be to link it with money. During the past it worked quite well as the money that was issued was linked to gold. So every central bank needed enough gold to pay back all of the money it issued. However, before 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 are printing money, so put simply they’re “creating wealth” out of thin air without really having it. This process not only exposes us to risks of economic collapse nonetheless it results also with the de-valuation of money. Therefore, because money will probably be worth less, whoever is selling something must raise the price of goods to reflect their real value, this is called inflation. But what’s behind coincapcentral ? Why are central banks doing this? Well the answer they would 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 is not the only real reason. By issuing fresh money we are able to afford to cover back the debts we’d, basically we make new debts to pay the old ones. But that’s 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 easier to grow because debts are cheap. But what are the consequences of all this? It’s hard to store wealth. If you keep the money (you worked hard to get) in your money you are actually losing wealth because your cash is de-valuing pretty quickly.
Because each central bank has an inflation target at around 2% we can well say that keeping money costs most 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 might be caused by a rise of value of money. To begin with, it could hurt spending as consumers will undoubtedly be incentivised to save lots of money because their value increase overtime. Alternatively merchants will be under constant pressure. They will have to sell their goods quick otherwise they will lose money because the price they will charge because of 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 probably the most is DEBT!!. In a deflationary environment debt will become a real burden since 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 founded on debt. Which means future generations can pay our debts. Deflation however 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 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 will never have a lot more than 21 million bitcoins around. Therefore they are designed to be deflationary. Now we have all seen what the consequences of deflation are. However, in a bitcoin-based future it would 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. In fact, because contracting debts in bitcoins will be very expensive business can still have 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 undoubtedly be distributed more evenly among people. However, simply for clarity, I have to say that part of the costs of borrowing capital will undoubtedly 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 might 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 people inherited from days gone by generations.