Recently I started buying bitcoins and I’ve heard a lot of talks about inflation and deflation but not many people actually know and consider what inflation and deflation are. But let’s focus on inflation.
We always needed a method to trade value and probably the most practical way to do it is to link it with money. In past times it worked quite well because the money that has been issued was linked to gold. So every central bank had to have enough gold to pay 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. Since you can guess it’s very easy to abuse to such power and certainly the major central banks aren’t renouncing to do so. For this reason they are printing money, so basically they’re “creating wealth” out of thin air without really having it. This technique not merely 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, this is called inflation. But what’s behind the money printing? Why are central banks doing this? Well the answer they would offer you is that by de-valuing their currency they’re helping the exports.
In fairness, inside 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’d, basically 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 which are the consequences of all this? It’s hard to store wealth. If you keep carefully the money (you worked hard to get) in your money you’re actually losing wealth because your money 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% per 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 often the opposite of inflation and it is the biggest nightmare for the central banks, let’s understand why. Basically, we have deflation when overall the prices 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 lots of money because their value increase overtime. However merchants will undoubtedly be under constant pressure. They’ll have to sell their goods quick otherwise they will lose money as the price they will charge for their services will drop as time passes. But if 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 since it will only get bigger over time. Because our economies are based on debt you can imagine exactly what will function as consequences of deflation.
So to summarize, inflation is growth friendly but is founded on debt. Therefore the future generations will pay our debts. Deflation however makes growth harder but it means that future generations won’t have much debt to pay (in such context it might be possible to afford 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’re 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 the debt-based economy to a share-based economy. In fact, because contracting debts in bitcoins would be very expensive business can still obtain 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 be distributed more evenly among people. However, simply for clarity, I must say that area of the costs of borrowing capital will be reduced under bitcoins 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, Bitcoin Era will face many problems unfortunately, as governments still need fiat money to cover back the huge debts that we inherited from days gone by generations.