Recently I started investing in bitcoins and I’ve heard a lot of talks about inflation and deflation however, not lots of 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 because the money that has been issued was associated with gold. So every central bank had to have enough gold to cover back all of the money it issued. However, in the past century this changed and gold isn’t what’s giving value to money but promises. Since technical analysis can guess it’s very an easy task to abuse to such power and certainly the major central banks are not renouncing to do so. For this reason they’re printing money, so basically 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, that is called inflation. But what’s behind the money printing? Why are central banks doing so? Well the answer they would offer you is that by de-valuing their currency they are helping the exports.
In fairness, inside our global economy that 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’d, quite simply 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 better 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 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 are able to 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 our central banks, let’s see why. Basically, we have deflation when overall the prices of goods fall. This might be caused by an increase of value of money. Firstly, it would hurt spending as consumers will be incentivised to save money because their value increase overtime. On the other hand merchants will be under constant pressure. They’ll need to sell their goods quick otherwise they will lose money because the price they will charge because of their services will drop over time. But if 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 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 be the consequences of deflation.
So to conclude, inflation is growth friendly but is founded on debt. Therefore the future generations will pay our debts. Deflation on the other hand makes growth harder but it implies that future generations won’t have much debt to pay (in such context it will be possible to cover slow growth).
OK so how all of this fits with bitcoins?
Well, bitcoins are made to be an alternative for 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 more than 21 million bitcoins around. Therefore they’re designed to be deflationary. Now we have all seen what the consequences 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 a 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 want by issuing shares of these company. This could be an interesting alternative as it will offer many investment opportunities and the wealth generated will undoubtedly be distributed more evenly among people. However, just for clarity, I have to say that portion of the costs of borrowing capital will undoubtedly be reduced under bitcoins as 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 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 people inherited from the past generations.