Recently I started buying bitcoins and I’ve heard a lot 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 the most practical way to do it would be to link it with money. Before it worked quite well as the money that was issued was associated with gold. So every central bank had to have enough gold to cover back all the money it issued. However, in 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. That is why they are printing money, so put simply they’re “creating wealth” out of thin air without really having it. This technique not only 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, this is called inflation. But what’s behind the money printing? Why are central banks doing this? Well the answer they might give you is that by de-valuing their currency they’re helping the exports.
In fairness, in our global economy this is true. However, that’s not the only reason. By issuing fresh money we are able to afford to pay back the debts we’d, put simply we make new debts to cover the old ones. But that is not only it, by de-valuing our currencies we are de-facto de-valuing our debts. That’s why our countries love inflation. In coincapcentral to grow because debts are cheap. But which are the consequences of all this? It’s hard to store wealth. So if you keep carefully the money (you worked hard to obtain) 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% each 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 exactly the opposite of inflation and it is the biggest nightmare for the central banks, let’s see why. Basically, we’ve deflation when overall the costs of goods fall. This would be caused by a rise of value of money. For starters, it could hurt spending as consumers will be incentivised to save money because their value will increase overtime. However merchants will be under constant pressure. They will have to sell their goods quick otherwise they’ll lose money because the price they will charge for 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 the most is DEBT!!. In a deflationary environment debt can be a real burden as it will only get bigger over time. Because our economies are based on debt you can imagine what will function as consequences of deflation.
So to summarize, inflation is growth friendly but is based on debt. Therefore the 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 would be possible to afford slow growth).
OK so how all of this fits with bitcoins?
Well, bitcoins are designed to be an alternative for money also to be both a store of value and a mean for trading goods. They’re limited in number and we will never have a lot more than 21 million bitcoins around. Therefore they’re 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 easy 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 costly business can still have the capital they want by issuing shares of these 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, just for clarity, I have to say that area of the costs of borrowing capital will undoubtedly be reduced under bitcoins as the fees will be extremely low and there won’t 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.