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 consider 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 would be to link it with money. Previously it worked quite well as the money that has been issued was linked to gold. So every central bank had to have enough gold to pay back all of the money it issued. However, in the past century this changed and gold is not what’s 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. Because of this they’re printing money, so put simply they’re “creating wealth” out of thin air without really having it. This process not merely 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, this is called inflation. But what’s behind the amount of money printing? Why are Bitcoin Era Site doing this? Well the answer they might give you is that by de-valuing their currency they are 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 cover back the debts we had, 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 easier 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 money you’re actually losing wealth because your money is de-valuing pretty quickly.
Because each central bank comes with an inflation target at around 2% we are able to 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 might be caused by a rise of value of money. To start with, it would hurt spending as consumers will undoubtedly be incentivised to save money because their value increase overtime. On the other hand merchants will undoubtedly 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 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 will become a real burden since 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 in summary, inflation is growth friendly but is based on debt. Therefore the future generations can pay our debts. Deflation however makes growth harder but it means that future generations won’t have much debt to cover (in such context it would be possible to cover slow growth).
OK so how all 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 are limited in number and we will never have a lot more than 21 million bitcoins around. Therefore they’re designed to be deflationary. Now we have all seen what the consequences of deflation are. However, in a bitcoin-based future it would 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 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 many investment opportunities and the wealth generated will be distributed more evenly among people. However, just for clarity, I must say that the main costs of borrowing capital will undoubtedly 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 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 the past generations.