Recently I started buying bitcoins and I’ve heard a great deal of talks about inflation and deflation however, not many people actually know and think about what inflation and deflation are. But let’s start with inflation.
We always needed ways to trade value and probably the most practical way to do it is to link it with money. In the past it worked quite well because the money that was issued was linked to gold. So every central bank had to have enough gold to pay back all the money it issued. However, in past times century this changed and gold is not 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. Because of this they are printing money, so quite simply 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 is worth less, whoever is selling something must raise the price of goods to reflect their real value, this is called inflation. But what’s behind the amount of money printing? Why are central banks doing so? Well the answer they might offer 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 cover 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 easier to grow because debts are cheap. But which are the consequences of all this? It’s hard to store wealth. So if you keep carefully the money (you worked hard to obtain) in your bank account you are actually losing wealth because your money 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 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 and it is the biggest nightmare for the central banks, let’s understand why. Basically, we have deflation when overall the prices of goods fall. This would be caused by a rise of value of money. First of all, it could hurt spending as consumers will undoubtedly be incentivised to save lots of money because their value will increase overtime. On the other hand 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 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 what will be the consequences of deflation.
So to conclude, inflation is growth friendly but is founded on debt. Therefore the future generations will pay our debts. Bitcoin Revolution on the other hand makes growth harder but it implies that future generations won’t have much debt to pay (in such context it could be possible to afford slow growth).
OK so how all 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’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 results of deflation are. However, in a bitcoin-based future it could still be easy for businesses to thrive. The ideal solution will be to switch from a debt-based economy to a share-based economy. Actually, because contracting debts in bitcoins would be very costly business can still obtain the capital they need 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 be distributed more evenly among people. However, simply for clarity, I have to say that the main costs of borrowing capital will be reduced under bitcoins as the fees will be extremely low and there won’t 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 cover back the huge debts that we inherited from the past generations.