Recently I started buying bitcoins and I’ve heard a great deal of discusses 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 a way to trade value and probably the most practical way to take action is to link it with money. During the past it worked quite well because the money that has been issued was linked to gold. So every central bank had to have enough gold to pay 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. As you 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. Because of this they’re printing money, so quite simply they are “creating wealth” out of nothing without really having it. This process not only 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 raise 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 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 that is true. However, that is not the only real reason. By issuing fresh money we can afford to pay back the debts we had, put simply we make new debts to cover the old ones. But that’s 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 easier to grow because debts are cheap. But which 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 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% 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 in fact it is the biggest nightmare for the central banks, let’s see why. Basically, we’ve deflation when overall the prices of goods fall. This would be caused by an increase of value of money. To start with, it could hurt spending as consumers will be incentivised to save money because their value increase overtime. However merchants will undoubtedly be under constant pressure. They will 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 a deflationary environment debt will become a real burden as it will only get bigger over time. Because our economies are based on debt you can imagine exactly what will function as consequences of deflation.
So to conclude, inflation is growth friendly but is founded on debt. Which means future generations can pay our debts. Deflation alternatively makes growth harder but it means 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 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 bitcoin s around. Therefore they are designed to be deflationary. We now have all seen what the results 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. Actually, because contracting debts in bitcoins will 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 undoubtedly be distributed more evenly among people. However, just for clarity, I have to say that the main 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 cover back the huge debts that we inherited from days gone by generations.