Recently I started buying bitcoins and I’ve heard a great deal of talks about inflation and deflation however, not lots of 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 the past it worked quite well because the money that was issued was linked to gold. So every central bank needed enough gold to cover back all the money it issued. However, before century this changed and gold is not what is giving value to money but promises. As you can guess it’s very an easy task to abuse to such power and certainly the major central banks are not renouncing to do so. Because of this they’re printing money, so quite simply they’re “creating wealth” out of thin air without really having it. This process 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 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 central banks doing this? Well the answer they might 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 is not the only reason. By issuing fresh money we can afford to cover back the debts we’d, in other words we make new debts to cover the old ones. But that is 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 better 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 are actually losing wealth because your money is de-valuing pretty quickly.
Because Bitcoin Revolution has an inflation target at around 2% we are able to well say that keeping money costs most 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 and it is the biggest nightmare for our central banks, let’s see why. Basically, we’ve deflation when overall the prices of goods fall. This might be caused by an increase of value of money. For starters, it could hurt spending as consumers will be incentivised to save money because their value will increase overtime. However merchants will undoubtedly be under constant pressure. They will have to sell their goods quick otherwise they will lose money because the price they will charge for 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 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 exactly what will be the consequences of deflation.
So in summary, inflation is growth friendly but is founded on debt. Which means future generations will pay our debts. Deflation alternatively makes growth harder nonetheless it means that future generations won’t have much debt to pay (in such context it could be possible to afford slow growth).
OK so how all of this fits with bitcoins?
Well, bitcoins are made to be an alternative for the money also to be both a store of value and a mean for trading goods. They are limited in number and we’ll never have a lot more than 21 million bitcoins around. Therefore they are 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 a debt-based economy to a share-based economy. In fact, because contracting debts in bitcoins will be very costly 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 undoubtedly be distributed more evenly among people. However, simply for clarity, I have to say that part of the costs of borrowing capital will undoubtedly be reduced under bitcoins because the fees would be extremely low and there won’t be intermediaries between transactions (banks rip people off, both borrowers and lenders). This would 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 we inherited from the past generations.