Recently I started investing in bitcoins and I’ve heard a lot of discusses inflation and deflation but not lots of people actually know and think about 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 take action would be 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 pay 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 you can guess it’s very easy to abuse to such power and certainly the major central banks aren’t renouncing to do so. Because of this they’re printing money, so quite simply they are “creating wealth” out of thin air without really having it. This process not merely exposes us to risks of economic collapse but 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, this is called inflation. But what’s behind the money printing? Why are central banks doing so? Well the answer they would give you is that by de-valuing their currency they are helping the exports.
In fairness, in our global economy that is true. However, that’s not the only 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 are 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? It’s hard to store wealth. If you keep carefully the money (you worked hard to obtain) in your bank account you are 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% 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 in fact it is the biggest nightmare for our 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. For starters, it could hurt spending as consumers will undoubtedly be incentivised to save lots of money because their value will increase overtime. However merchants will undoubtedly be under constant pressure. They’ll have to sell their goods quick otherwise they’ll lose money as the price they will charge for their services will drop over time. But when there is coincapcentral 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 will become a real burden as it will only get bigger as time passes. Because our economies are based on debt you can imagine exactly what will function as consequences of deflation.
So in summary, inflation is growth friendly but is based on debt. Which means future generations can pay our debts. Deflation alternatively makes growth harder but it means that future generations won’t have much debt to pay (in such context it will be possible to cover slow growth).
OK so how all this fits with bitcoins?
Well, bitcoins are made to be an alternative for 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 a lot more than 21 million bitcoins around. Therefore they are designed to be deflationary. Now we have all seen what the consequences 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 the debt-based economy to a share-based economy. Actually, because contracting debts in bitcoins will be very expensive business can still obtain the capital they need 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, just for clarity, I have to say that portion of the costs of borrowing capital will undoubtedly be reduced under bitcoins because the fees will be extremely low and there will not be intermediaries between transactions (banks rip people off, both borrowers and lenders). This might 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 we inherited from the past generations.