Recently I started investing in bitcoins and I’ve heard a great deal of discusses 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 the most practical way to do it 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 worldoftechnicalanalysis.com had to have enough gold to cover back all of the money it issued. However, before century this changed and gold isn’t what’s 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 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 has to 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 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 real reason. By issuing fresh money we can afford to pay 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 have been de-facto de-valuing our debts. That is why our countries love inflation. In inflationary environments it’s simpler to grow because debts are cheap. But which are the consequences of most 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% 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 exactly the opposite of inflation in fact it is the biggest nightmare for the central banks, let’s understand why. Basically, we’ve deflation when overall the costs of goods fall. This would be caused by a rise of value of money. Firstly, it would hurt spending as consumers will be incentivised to save money because their value 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 because the price they will charge because of their services will drop as time passes. 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 as time passes. 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. Which means future generations will pay our debts. Deflation on the other hand makes growth harder nonetheless it implies 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 designed to be an alternative for money and 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. 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 way to go 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 obtain the capital they need 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, simply for clarity, I must say that the main costs of borrowing capital will undoubtedly be reduced under bitcoins as the fees will be extremely low and there will not be intermediaries between transactions (banks rip people off, both borrowers and lenders). This might buffer a number of the negative sides of deflation. Nevertheless, bitcoins will face many problems unfortunately, as governments still need fiat money to pay back the huge debts that people inherited from the past generations.