Recently I started buying bitcoins and I’ve heard a lot of talks about inflation and deflation however, not lots of people actually know and think about what inflation and deflation are. But let’s focus on inflation.
We always needed a way to trade value and the most practical way to do it is to link it with money. During the past it worked quite well as the money that was issued was associated with gold. So every central bank had to have enough gold to cover back all the money it issued. However, during the past century this changed and gold is not what’s 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 aren’t renouncing to do so. Because of this they are printing money, so in other words they are “creating wealth” out of nothing 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 is worth less, whoever is selling something must 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 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 that is true. However, that is not the only reason. By issuing fresh money we can afford to cover back the debts we had, put simply we make new debts to cover the old ones. But that’s not only it, by de-valuing our currencies we are de-facto de-valuing our debts. That’s 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. If you keep the money (you worked hard to obtain) in your bank account you’re actually losing wealth because your cash is de-valuing pretty quickly.
Because each central bank has 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 how our economies are working, predicated on inflation and debts.
What about deflation? Well this is often the opposite of inflation and it is the biggest nightmare for our central banks, let’s see why. Basically, we have deflation when overall the prices of goods fall. This might be caused by a rise of value of money. To begin with, it could hurt spending as consumers will be incentivised to save money because their value will increase overtime. However merchants will be under constant pressure. They will need to sell their goods quick otherwise they’ll lose money because the price they will charge for their 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 as time passes. Because our economies are based on debt you can imagine exactly what will be the consequences of deflation.
So to conclude, inflation is growth friendly but is founded on debt. Therefore the future generations can pay our debts. Deflation alternatively makes growth harder nonetheless it implies 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 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 consequences of deflation are. However, in a bitcoin-based future it could still be possible for businesses to thrive. The ideal solution will be to switch from the debt-based economy to a share-based economy. Actually, because contracting debts in bitcoins would be very expensive business can still have the capital they need by issuing shares of their 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 have to say that portion of the costs of borrowing capital will undoubtedly be reduced under bitcoins as 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, Bitcoin Era Review will face many problems unfortunately, as governments still need fiat money to pay back the huge debts that we inherited from days gone by generations.