Recently I started buying bitcoins and I’ve heard a lot of talks about inflation and deflation however, not many people actually know and consider what inflation and deflation are. But let’s start with inflation.
We always needed a method to trade value and the most practical way to take action would be to link it with money. Previously it worked quite well as the money that has been issued was associated with gold. So every central bank needed enough gold to pay back all of the money it issued. However, during the past century this changed and gold isn’t what is 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 aren’t renouncing to do so. For this reason they’re printing money, so in other words they’re “creating wealth” out of thin air without really having it. This technique 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 has to raise the price of goods to reflect their real value, that is called inflation. But what’s behind the amount of 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 that is true. However, that’s not the only real reason. By issuing fresh money we are able to afford to cover back the debts we had, quite simply we make new debts to cover the old ones. But that is 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? worldoftechnicalanalysis.com to store wealth. So if you keep carefully the money (you worked hard to get) 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% per 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 our 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. For starters, it could hurt spending as consumers will undoubtedly be incentivised to save money because their value increase overtime. Alternatively merchants will be under constant pressure. They’ll have to sell their goods quick otherwise they’ll lose money as the price they will charge for his or her services will drop as time passes. 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 the most is DEBT!!. In a deflationary environment debt can be a real burden since it will only get bigger as time passes. Because our economies are based on debt you can imagine what will function as consequences of deflation.
So in summary, inflation is growth friendly but is founded on debt. Which means future generations will pay our debts. Deflation however makes growth harder but it implies that future generations won’t have much debt to pay (in such context it could be possible to cover slow growth).
OK so how all of this fits with bitcoins?
Well, bitcoins are made 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 more than 21 million bitcoins around. Therefore they’re designed to be deflationary. We now 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. Actually, because contracting debts in bitcoins will be very expensive business can still have the capital they want by issuing shares of their 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, simply for clarity, I must 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 some 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.