Recently Bitcoin Era Official started investing in bitcoins and I’ve heard a lot of discusses inflation and deflation but not lots of people actually know and think about what inflation and deflation are. But let’s start with inflation.
We always needed ways to trade value and probably the most practical way to take action would be 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 needed enough gold to cover back all the money it issued. However, in past times century this changed and gold isn’t what’s giving value to money but promises. As 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. That is why they are printing money, so put simply they’re “creating wealth” out of nothing 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 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 so? Well the answer they might offer you is that by de-valuing their currency they’re helping the exports.
In fairness, in our global economy this is true. However, that is not the only real reason. By issuing fresh money we can afford to pay back the debts we had, quite simply we make new debts to cover the old ones. But that is 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 simpler to grow because debts are cheap. But what are the consequences of most this? It’s hard to store wealth. If you keep carefully the money (you worked hard to obtain) in your bank account 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 most of us at least 2% each 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 our central banks, let’s understand why. Basically, we’ve deflation when overall the prices of goods fall. This would be caused by an increase of value of money. To begin with, it would hurt spending as consumers will be incentivised to save money because their value will increase overtime. On the other hand merchants will be under constant pressure. They’ll have to sell their goods quick otherwise they will lose money because the price they will charge because of their services will drop as time passes. 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 will become a real burden since it will only get bigger over time. Because our economies are based on debt you can imagine what will be the consequences of deflation.
So to conclude, inflation is growth friendly but is founded on debt. Therefore the future generations can pay our debts. Deflation on the other hand makes growth harder but it implies that future generations won’t have much debt to pay (in such context it would be possible to cover slow growth).
OK so how all of this fits with bitcoins?
Well, bitcoins are designed to be an alternative for the money and to be both a store of value and a mean for trading goods. They are limited in number and we’ll never have more than 21 million bitcoins around. Therefore they are designed to be deflationary. We now have all seen what the results of deflation are. However, in a bitcoin-based future it would still be possible for businesses to thrive. The ideal solution 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 have the capital they want by issuing shares of their company. This could be a fascinating alternative as it will offer 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 be reduced under bitcoins because the fees would be extremely low and there will not 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 we inherited from days gone by generations.