Recently I started buying bitcoins and I’ve heard a lot of discusses inflation and deflation but not many people actually know and consider 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 take action is to link it with money. During the past it worked quite well as the money that has been issued was associated with gold. So every central bank had to have enough gold to cover back all the money it issued. However, during 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 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 put simply they’re “creating wealth” out of nothing without really having it. This process not only exposes us to risks of economic collapse nonetheless 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 amount of money printing? Why are central banks doing this? Well the answer they might 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 real reason. By issuing fresh money we can afford to pay back the debts we had, in other words we make new debts to pay the old ones. But that is not only it, by de-valuing our currencies we are de-facto de-valuing our debts. That’s 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. So if you keep 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 comes with 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, based 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 understand why. Basically, we have deflation when overall the costs of goods fall. This might be caused by an increase of value of money. To begin with, it could hurt spending as consumers will undoubtedly be incentivised to save money because their value increase overtime. Alternatively merchants will undoubtedly be under constant pressure. They will need to sell their goods quick otherwise they’ll lose money because the price they will charge for his or her services will drop as time passes. 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 will become a real burden as it will only get bigger as time passes. Because our economies derive from debt you can imagine exactly 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 alternatively makes growth harder but it implies that future generations won’t have much debt to cover (in such context it might be possible to cover slow growth).
OK so how all this fits with bitcoins?
Well, bitcoins are designed 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’ll never have a lot 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 could 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. In fact, because contracting debts in bitcoins will be very expensive business can still have the capital they need by issuing shares of their company. This could be a fascinating alternative as it will offer you many investment opportunities and the wealth generated will 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 because the fees will be extremely low and there won’t be intermediaries between transactions (banks rip people off, both borrowers and lenders). This would 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.