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 think about 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 because 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, in the past century this changed and gold isn’t 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 are not renouncing to do so. For this reason they are printing money, so put simply they’re “creating wealth” out of nothing 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, that is called inflation. But what’s behind the amount of money printing? Why are central banks doing this? Well the answer they would give you is that by de-valuing their currency they are helping the exports.
In fairness, inside 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 had, basically 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 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 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 are able to well say that keeping money costs all of us at least 2% per year. This discourages savers and spur consumes. This is how our economies are working, based on inflation and debts.
What about coincapcentral ? Well this is often the opposite of inflation and it is the biggest nightmare for our central banks, let’s understand why. Basically, we have deflation when overall the prices of goods fall. This might be caused by a rise of value of money. Firstly, it could hurt spending as consumers will be incentivised to save money because their value will increase overtime. Alternatively merchants will be under constant pressure. They will have to sell their goods quick otherwise they’ll lose money as the price they will charge for his or her services will drop as time passes. 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 as it will only get bigger over time. Because our economies derive from debt you can imagine what will be the consequences of deflation.
So in summary, 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 implies that future generations won’t have much debt to cover (in such context it would be possible to afford slow growth).
OK so how all this fits with bitcoins?
Well, bitcoins are made to be an alternative for the money and to be both a store of value and a mean for trading goods. They’re limited in number and we will 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 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 will be very expensive business can still have the capital they want by issuing shares of their company. This could be a fascinating alternative as it will offer you many investment opportunities and the wealth generated will undoubtedly be distributed more evenly among people. However, simply for clarity, I must say that area of the 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 would buffer some 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 days gone by generations.