Recently I started investing in bitcoins and I’ve heard a great deal of discusses inflation and deflation however, 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 do it is to link it with money. Previously 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 isn’t what is 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 aren’t renouncing to do so. For this reason they are printing money, so put simply they’re “creating wealth” out of thin air 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 has to increase the price of goods to reflect their real value, this is called inflation. But what’s behind the amount of money printing? Why are central banks doing so? Well the answer they might give 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 pay back the debts we had, quite simply we make new debts to cover the old ones. But that’s Bitcoin Revolution Official , 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 easier to grow because debts are cheap. But what are the consequences of all this? It’s hard to store wealth. So if you keep the money (you worked hard to get) in your bank account you’re actually losing wealth because your money is de-valuing pretty quickly.
Because each central bank has 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 often the opposite of inflation and it is the biggest nightmare for the 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 undoubtedly be incentivised to save lots of money because their value will increase overtime. On the other hand merchants will be under constant pressure. They will need 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 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 as it will only get bigger as time passes. Because our economies derive from 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 can 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 will be possible to afford slow growth).
OK so how all 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’re designed to be deflationary. We now have all seen what the results of deflation are. However, in a bitcoin-based future it could still be easy for businesses to thrive. The ideal solution will be to switch from the 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 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 have to say that portion 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 might 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 people inherited from days gone by generations.