Recently I started investing in bitcoins and I’ve heard a great deal of talks about inflation and deflation but not many people actually know and think about what inflation and deflation are. But let’s start with inflation.
We always needed a method to trade value and the most practical way to take action is to link it with money. In past times it worked quite well because the money that has been issued was associated with gold. So every central bank had to have enough gold to pay back all the money it issued. However, previously century this changed and gold isn’t what is giving value to money but promises. As possible 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’re printing money, so put simply they are “creating wealth” out of thin air without really having it. This technique not merely exposes us to risks of economic collapse but it results also with the de-valuation of money. Therefore, because money will probably be worth less, whoever is selling something has to raise 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, inside our global economy that is true. However, that’s not the only reason. By issuing fresh money we are able to afford to cover back the debts we had, in other words we make new debts to pay the old ones. But that’s not only it, by de-valuing our currencies we are de-facto de-valuing our debts. That is why our countries love inflation. In inflationary environments it’s better 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 are 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 most of us at least 2% per year. worldoftechnicalanalysis.com 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’ve deflation when overall the prices of goods fall. This might be caused by a rise 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 need to sell their goods quick otherwise they’ll lose money as 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 usually do not care much about consumers or merchants, what they care probably the most is DEBT!!. In a deflationary environment debt can be a real burden since it will only get bigger as time passes. Because our economies are based on debt you can imagine exactly what will function as consequences of deflation.
So in summary, inflation is growth friendly but is based on debt. Which means future generations can pay our debts. Deflation however makes growth harder nonetheless it means that future generations won’t have much debt to pay (in such context it might be possible to cover 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 will never have 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 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. In fact, because contracting debts in bitcoins will be very expensive business can still have the capital they need by issuing shares of these company. This could be a fascinating alternative as it will offer you many investment opportunities and the wealth generated will be distributed more evenly among people. However, just 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 will not 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.