Recently I started investing in bitcoins and I’ve heard a lot of talks about inflation and deflation but not many people actually know and consider what inflation and deflation are. But let’s focus on inflation.
Bitcoin Revolution Site needed a method to trade value and the most practical way to take action would be to link it with money. Before it worked quite well because the money that has been issued was linked to gold. So every central bank needed enough gold to pay back all of the money it issued. However, before century this changed and gold is not what is giving value to money but promises. Since 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 put simply they are “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 has to 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 might offer you is that by de-valuing their currency they are helping the exports.
In fairness, inside our global economy this is true. However, that is not the only reason. By issuing fresh money we can afford to cover back the debts we’d, 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 what are the consequences of most this? It’s hard to store wealth. So if you keep carefully the money (you worked hard to obtain) in your money you’re actually losing wealth because your money is de-valuing pretty quickly.
Because each central bank comes with an inflation target at around 2% we can 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 our 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. For starters, it could hurt spending as consumers will undoubtedly be incentivised to save money because their value will increase overtime. On the other hand merchants will undoubtedly be under constant pressure. They will need to sell their goods quick otherwise they’ll lose money as 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 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 as it will only get bigger over time. Because our economies are based on debt you can imagine what will be the consequences of deflation.
So in summary, inflation is growth friendly but is founded on debt. Which means future generations will pay our debts. Deflation alternatively makes growth harder nonetheless it implies that future generations won’t have much debt to pay (in such context it would be possible to cover slow growth).
OK so how all 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’ll never have a lot more than 21 million bitcoins around. Therefore they’re designed to be deflationary. Now we have all seen what the results of deflation are. However, in a bitcoin-based future it would still be easy for businesses to thrive. The way to go will be to switch from a debt-based economy to a share-based economy. Actually, because contracting debts in bitcoins will be very costly business can still have the capital they need by issuing shares of these 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, just for clarity, I must say that portion of the 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 would buffer a few 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 people inherited from the past generations.