Recently I started investing in bitcoins and I’ve heard a lot of discusses inflation and deflation but not lots of people actually know and think about what inflation and deflation are. But let’s start with inflation.
We always needed a way to trade value and probably the most practical way to do it is to link it with money. In past times it worked quite well as the money that has been issued was associated with gold. So every central bank needed enough gold to cover back all of the money it issued. However, in Bitcoin Evolution changed and gold isn’t what’s giving value to money but promises. Since you can guess it’s very easy to abuse to such power and certainly the major central banks are not renouncing to do so. That is why they are printing money, so basically they are “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 has to increase the price of goods to reflect their real value, this 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, in our global economy this is true. However, that’s not the only 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 is why our countries love inflation. In inflationary environments it’s better 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 get) in your money you’re actually losing wealth because your cash is de-valuing pretty quickly.
Because each central bank comes with an inflation target at around 2% we can well say that keeping money costs most 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 in fact it is the biggest nightmare for our central banks, let’s understand why. Basically, we have deflation when overall the prices of goods fall. This might be caused by an increase of value of money. To begin with, it would hurt spending as consumers will undoubtedly be incentivised to save lots of money because their value increase overtime. However 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 because of 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 since it will only get bigger over time. Because our economies derive from debt you can imagine exactly what will function as consequences of deflation.
So to summarize, inflation is growth friendly but is founded on debt. Which means future generations will pay our debts. Deflation however makes growth harder nonetheless it means 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 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 are limited in number and we will never have a lot more than 21 million bitcoins around. Therefore they’re designed to be deflationary. We now 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 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 costly business can still have the capital they want by issuing shares of these company. This could be an interesting alternative as it will offer you 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 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.