Recently I started buying bitcoins and I’ve heard a lot of discusses inflation and deflation but not lots of people actually know and consider 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 do it is to link it with money. In past times it worked quite well as the money that was issued was linked to gold. So every central bank needed enough gold to cover back all of the money it issued. However, in the past century this changed and gold is not what’s giving value to money but promises. As possible guess it’s very an easy task to abuse to such power and certainly the major central banks aren’t renouncing to do so. That is why they’re printing money, so basically they are “creating wealth” out of nothing without really having it. This technique not merely 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 raise the price of goods to reflect their real value, this is called inflation. But what’s behind the 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, in our global economy that is true. However, that’s not the only real reason. By issuing fresh money we are able to afford to pay back the debts we had, quite simply 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 get) in your money 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 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 and 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 might be caused by a rise of value of money. First of all, it could hurt spending as consumers will be incentivised to save money because their value will increase overtime. On the other hand merchants will be under constant pressure. They’ll need to sell their goods quick otherwise they will lose money because the price they will charge because of their services will drop over time. 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 probably 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 derive from debt you can imagine exactly what will be the consequences of deflation.
So in summary, inflation is growth friendly but is based on debt. Therefore the future generations can pay our debts. Deflation however makes growth harder but it means that future generations won’t have much debt to cover (in such context it would 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 also to be both a store of value and a mean for trading goods. They are limited in number and we’ll never have more than 21 million bitcoins 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. coincapcentral to go will be to switch from a debt-based economy to a share-based economy. In fact, because contracting debts in bitcoins will be very expensive business can still obtain the capital they need by issuing shares of these 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, just for clarity, I must say that part of the costs of borrowing capital will be reduced under bitcoins as the fees would be extremely low and there won’t 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 pay back the huge debts that we inherited from the past generations.