Recently I started buying bitcoins and I’ve heard a great deal of discusses inflation and deflation but not lots of 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 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 pay back all of the money it issued. However, in the past century this changed and gold isn’t what is 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’re printing money, so basically 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 has to increase 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 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 can afford to pay back the debts we had, put simply we make new debts to pay the old ones. But that’s not only it, by de-valuing our currencies we are de-facto de-valuing our debts. That is why our countries love inflation. In inflationary environments it’s better to grow because debts are cheap. But which 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 most of us at least 2% each year. This discourages savers and spur consumes. This is one way 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 see why. Basically, we’ve deflation when overall the costs of goods fall. This might be caused by an increase of value of money. To start with, it could hurt spending as consumers will be incentivised to save money because their value will increase overtime. Alternatively merchants will undoubtedly 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 as time passes. 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 the most is DEBT!!. In a deflationary environment debt will become a real burden as it will only get bigger over time. Because our economies derive from debt you can imagine what will be the consequences of deflation.
So in summary, inflation is growth friendly but is based 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 cover (in such context it might be possible to cover slow growth).
OK so how all of this fits with bitcoins?
Well, bitcoins are designed to be an alternative for the money also to be both a store of value and a mean for trading goods. They’re limited in number and we will never have 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 ideal solution will be to switch from the debt-based economy to a share-based economy. Actually, because contracting debts in bitcoins would be very expensive business can still have the capital they want 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 the main costs of borrowing capital will undoubtedly be reduced under bitcoin s because 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 a few 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.