What Is Inflation and Deflation and a Speculation Concerning the Bitcoin Future
Recently I started buying bitcoins and I’ve heard a lot of discusses inflation and deflation but not lots of people actually know and think about what inflation and deflation are. But let’s focus on inflation.
We always needed a method to trade value and probably the most practical way to do it would be to link it with money. Previously it worked quite well because the money that has been 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’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 are not 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 but it results also with the de-valuation of money. Therefore, because money will probably be worth less, whoever is selling something has to 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 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’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’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 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’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% each year. This discourages savers and spur consumes. This is how our economies are working, based on inflation and debts.
What about deflation? Well coincapcentral is exactly the opposite of inflation in fact it is the biggest nightmare for our central banks, let’s understand why. Basically, we’ve deflation when overall the costs of goods fall. This might be caused by a rise of value of money. To start with, it could hurt spending as consumers will undoubtedly be incentivised to save lots of money because their value will increase overtime. However merchants will be under constant pressure. They will need to sell their goods quick otherwise they will lose money because the price they will charge because of their 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 probably 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 summarize, inflation is growth friendly but is founded on debt. Therefore the future generations can pay our debts. Deflation on the other hand makes growth harder nonetheless 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 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 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 obtain the capital they need 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, just for clarity, I have to say that the main costs of borrowing capital will undoubtedly be reduced under bitcoins as the fees will be extremely low and there won’t 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 we inherited from the past generations.