What Is Inflation and Deflation and a Speculation About the Bitcoin Future
Recently I started investing in bitcoins and I’ve heard a great deal of discusses inflation and deflation however, 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 the past it worked quite Coinjoin well because the money that has been issued was linked to gold. So every central bank had to have 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 possible guess it’s very an easy task to abuse to such power and certainly the major central banks aren’t renouncing to do so. That is why they’re printing money, so put simply they are “creating wealth” out of thin air without really having it. This technique 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 raise 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, in our global economy this is true. However, that is not the only real reason. By issuing fresh money we are able to afford to pay back the debts we’d, put simply 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 which are the consequences of most this? It’s hard to store wealth. So if you keep carefully the money (you worked hard to get) 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 most 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 deflation? Well this is often the opposite of inflation in fact 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. To start with, it would hurt spending as consumers will undoubtedly be incentivised to save money because their value will increase overtime. Alternatively merchants will undoubtedly be under constant pressure. They’ll need to sell their goods quick otherwise they will lose money because 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 do not care much about consumers or merchants, what they care the most is DEBT!!. In a deflationary environment debt will become a real burden as it will only get bigger as time passes. Because our economies derive from debt you can imagine exactly 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 alternatively 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 of this fits with bitcoins?
Well, bitcoins are designed to be an alternative for the money also to be both a store of value and a mean for trading goods. They’re limited in number and we will never have a lot more than 21 million bitcoins around. Therefore they are designed to be deflationary. Now we 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. In fact, because contracting debts in bitcoins will be very costly business can still obtain 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 be distributed more evenly among people. However, just for clarity, I have to say that part of the costs of borrowing capital will 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 might buffer a few 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.