Recently I started investing in bitcoins and I’ve heard a great deal 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 ways to trade value and the most practical way to take action would be to link it with money. Before it worked quite well because the money that was 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 isn’t what is giving value to money but promises. As possible guess it’s very easy to abuse to such power and certainly the major central banks are not renouncing to do so. That is why they’re printing money, so basically they’re “creating wealth” out of nothing without really having it. worldoftechnicalanalysis.com 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, 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, in our global economy that is true. However, that’s not the only reason. By issuing fresh money we can afford to cover 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 are 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 bank account 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 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 how our economies are working, based on inflation and debts.
What about deflation? Well this is often the opposite of inflation and it is the biggest nightmare for the 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 would hurt spending as consumers will be incentivised to save money because their value increase overtime. Alternatively 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 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 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 are based on debt you can imagine what will function as consequences of deflation.
So to conclude, inflation is growth friendly but is founded on debt. Which means future generations will pay our debts. Deflation on the other hand makes growth harder nonetheless it means that future generations won’t have much debt to pay (in such context it will 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’re limited in number and we’ll never have 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 would still be possible for businesses to thrive. The way to go will be to switch from a debt-based economy to a share-based economy. Actually, because contracting debts in bitcoins will be very expensive business can still obtain the capital they need by issuing shares of these 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 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 cover back the huge debts that people inherited from days gone by generations.