Recently I started buying bitcoins and I’ve heard a great deal of talks about inflation and deflation however, not many people actually know and consider what inflation and deflation are. But let’s start with inflation.
We always needed a way to trade value and the most practical way to do it is to link it with money. During the past it worked quite well as the money that was issued was linked to gold. So every central bank had to have enough gold to cover back all of the money it issued. However, previously century this changed and gold isn’t what’s 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. That is why they are printing money, so quite simply they’re “creating wealth” out of nothing without really having it. This process not only 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 must increase 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 can afford to cover back the debts we had, quite simply we make new debts to cover the old ones. But that’s 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 better to grow because debts are cheap. But what 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 bank account you’re actually losing wealth because your money is de-valuing pretty quickly.
Because each central bank has 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, 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 a rise of value of money. For Bitcoin Era , it could hurt spending as consumers will be incentivised to save money because their value will increase overtime. Alternatively merchants will be under constant pressure. They will have to sell their goods quick otherwise they’ll lose money as the price they will charge for his or her services will drop over time. But if 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 the most is DEBT!!. In a deflationary environment debt can be a real burden since it will only get bigger over time. Because our economies are based on debt you can imagine exactly what will be the consequences of deflation.
So to summarize, inflation is growth friendly but is founded on debt. Which means future generations will pay our debts. Deflation on the other hand 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 the money and 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 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 possible 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 costly business can still obtain the capital they want by issuing shares of their company. This could be an interesting 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 part 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 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 we inherited from the past generations.