Recently I started investing in bitcoins and I’ve heard a lot of talks about inflation and deflation however, not many 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 probably the most practical way to do it is to link it with money. In the past 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 of the money it issued. However, in the past century this changed and gold isn’t what’s giving value to money but promises. Since you can guess it’s very an easy task to abuse to such power and certainly the major central banks aren’t renouncing to do so. For this reason they’re printing money, so in other words they’re “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 is 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 Bitcoin Revolution Site doing this? Well the answer they would offer 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 real reason. By issuing fresh money we are able to afford to cover back the debts we had, put simply 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’s 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. 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 comes with 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 how our economies are working, predicated on inflation and debts.
What about deflation? Well this is often the opposite of inflation in fact 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 would be caused by an increase of value of money. To start with, it would hurt spending as consumers will undoubtedly be incentivised to save lots of money because their value increase overtime. Alternatively merchants will be under constant pressure. They will have to sell their goods quick otherwise they’ll lose money because the price they will charge for his or her 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 will become a real burden since it will only get bigger as time passes. 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 can pay our debts. Deflation alternatively makes growth harder but it implies that future generations won’t have much debt to pay (in such context it could be possible to cover slow growth).
OK so how all this fits with bitcoins?
Well, bitcoins are made to be an alternative for money also to be both a store of value and a mean for trading goods. They are limited in number and we will never have 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 easy 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 would be very costly 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 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 because the fees would 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 cover back the huge debts that people inherited from days gone by generations.