Recently I started buying 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 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. Before 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, previously century this changed and gold isn’t 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. That is why they are printing money, so quite simply they are “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 must 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’re 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 can afford to cover back the debts we had, 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 simpler to grow because debts are cheap. But what are the consequences of all this? It’s hard to store wealth. If you keep carefully the money (you worked hard to get) in your bank account 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% 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’ve deflation when overall the prices of goods fall. This would be caused by a rise of value of money. First of all, it would hurt spending as consumers will undoubtedly be incentivised to save money because their value will increase overtime. However merchants will be under constant pressure. They will need to sell their goods quick otherwise they’ll lose money because the price they will charge because of their services will drop over time. But when 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 a deflationary environment debt can be a real burden since it will only get bigger over time. Because Bitcoin Era are based on debt you can imagine what will be the consequences of deflation.
So to summarize, inflation is growth friendly but is founded on debt. Therefore the future generations can pay our debts. Deflation however makes growth harder but it implies that future generations won’t have much debt to cover (in such context it could be possible to cover slow growth).
OK so how all this fits with bitcoins?
Well, bitcoins are made to be an alternative for money also 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 could still be easy 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 debts in bitcoins would 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 many investment opportunities and the wealth generated will be distributed more evenly among people. However, just for clarity, I have to say that area of the costs of borrowing capital will be reduced under bitcoins because 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 number 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.