Recently I started investing in bitcoins and I’ve heard a great deal of talks about 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 way to trade value and probably the most practical way to do it would be to link it with money. Before it worked quite well because the money that was issued was associated with gold. So every central bank had to have enough gold to pay back all the money it issued. However, previously century this changed and gold is not what’s giving value to money but promises. Since you can guess it’s very an easy task 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 process not merely exposes us to risks of economic collapse nonetheless 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 might give you is that by de-valuing their currency they are helping the exports.
In fairness, inside our global economy that is true. However, that is not the only real reason. By issuing fresh money we are able to 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 easier to grow because debts are cheap. But which are the consequences of all 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 money 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% each year. This discourages savers and spur consumes. This is how our economies are working, based 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 costs of goods fall. This might be caused by an increase of value of money. To begin with, it would 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 have to sell their goods quick otherwise they’ll lose money as 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 do not care much about consumers or merchants, what they care probably the most is DEBT!!. In a deflationary environment debt will become a real burden since it will only get bigger as time passes. Because our economies are based on debt you can imagine exactly what will be the consequences of deflation.
So to conclude, inflation is growth friendly but is founded on debt. Therefore the future generations will pay our debts. Deflation alternatively makes growth harder nonetheless it means that future generations won’t have much debt to cover (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 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’re designed to be deflationary. Now we have all seen what the consequences 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 the debt-based economy to a share-based economy. In fact, because contracting debts in bitcoins will 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 you many investment opportunities and the wealth generated will undoubtedly be distributed more evenly among people. However, simply for Bitcoin Era , I have to say that the main costs of borrowing capital will be reduced under bitcoins as 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 people inherited from days gone by generations.