Recently I started buying bitcoins and I’ve heard a lot of discusses inflation and deflation however, not many people actually know and consider what inflation and deflation are. But let’s start with inflation.
coincapcentral needed ways to trade value and the most practical way to do it would be to link it with money. Before it worked quite well as the money that has been issued was associated with gold. So every central bank needed enough gold to pay back all the money it issued. However, during the past century this changed and gold is not 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 aren’t renouncing to do so. Because of this they are printing money, so in other words they’re “creating wealth” out of nothing without really having it. This process not only 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, that is called inflation. But what’s behind the amount of money printing? Why are central banks doing this? Well the answer they would 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’s not the only reason. By issuing fresh money we can afford to pay back the debts we’d, basically we make new debts to pay the old ones. But that’s not only it, by de-valuing our currencies we have been 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 most this? It’s hard to store wealth. So if you keep the money (you worked hard to get) in your money 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 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, based on inflation and debts.
What about deflation? Well this is exactly the opposite of inflation in fact it is the biggest nightmare for our central banks, let’s understand why. Basically, we’ve deflation when overall the prices of goods fall. This would be caused by a rise of value of money. For starters, it would hurt spending as consumers will undoubtedly be incentivised to save money because their value increase overtime. However merchants will undoubtedly be under constant pressure. They will need to sell their goods quick otherwise they will lose money because the price they will charge for their 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 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 what will be the consequences of deflation.
So in summary, inflation is growth friendly but is founded on debt. Therefore the future generations will pay our debts. Deflation alternatively makes growth harder but it implies 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 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 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 results of deflation are. However, in a bitcoin-based future it could 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 costly business can still have the capital they want by issuing shares of these company. This could be a fascinating alternative as it will offer many investment opportunities and the wealth generated will undoubtedly be distributed more evenly among people. However, simply for clarity, I must say that part of the costs of borrowing capital will be reduced under bitcoins as the fees would be extremely low and there won’t be intermediaries between transactions (banks rip people off, both borrowers and lenders). This might buffer a number 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 people inherited from the past generations.