Recently I started investing in bitcoins and I’ve heard a great deal of discusses inflation and deflation but not lots of people actually know and consider what inflation and deflation are. But let’s start with inflation.
We always needed a method to trade value and 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 needed enough gold to cover back all 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 are not renouncing to do so. For this reason they are printing money, so put simply they are “creating wealth” out of thin air without really having it. This technique 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, that 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, in our global economy that is true. However, that is not the only reason. By issuing fresh money we are able to afford to pay back the debts we had, basically we make new debts to cover the old ones. But that is 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 easier to grow because debts are cheap. But what are the consequences of most this? It’s hard to store wealth. If you keep the money (you worked hard to get) in your money 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 can well say that keeping money costs all of us at least 2% per 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 exactly the opposite of inflation in fact it is the biggest nightmare for the central banks, let’s see why. Basically, we have deflation when overall the prices of goods fall. This would be caused by an increase of value of money. Firstly, it could hurt spending as consumers will undoubtedly be incentivised to save lots of money because their value 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 when 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 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 what will be the consequences of deflation.
So to summarize, inflation is growth friendly but is founded on debt. Therefore the 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 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’re limited in number and we’ll never have a lot more than 21 million bitcoins around. Therefore they’re designed to be deflationary. Now coincapcentral 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 way to go will be to switch from a debt-based economy to a share-based economy. Actually, because contracting debts in bitcoins would be very expensive business can still obtain the capital they need by issuing shares of their 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, simply for clarity, I have to say that the main costs of borrowing capital will be reduced under bitcoins because the fees would be extremely low and there won’t be intermediaries between transactions (banks rip people off, both borrowers and lenders). This would 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 people inherited from the past generations.