WHAT’S Inflation and Deflation and a Speculation About the Bitcoin Future
Recently I started investing in bitcoins and I’ve heard a lot of talks about inflation and deflation but 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 the most practical way to take action would be to link it with money. Previously 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 past times century this changed and gold isn’t what’s giving value to money but promises. As you can guess it’s very easy to abuse to such power and certainly the major central banks aren’t renouncing to do so. That is why they are printing money, so in other words they are “creating wealth” out of nothing without really having it. This process not merely 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, that is called inflation. But what’s behind the amount of money printing? Why are central banks doing this? Well the answer they would offer you is that by de-valuing their currency they’re helping the exports.
In fairness, in 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’d, basically 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 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 the money (you worked hard to get) in your money you are actually losing wealth because your money is de-valuing pretty quickly.
Because each central bank has an inflation target at around 2% we are able to well say that keeping money costs all of us at least 2% per year. This discourages savers and spur consumes. This is one way our economies are working, based on inflation and debts.
What about deflation? Well this is exactly the opposite of inflation and it is the biggest nightmare for the central banks, let’s see why. Basically, we’ve deflation when overall the costs of goods fall. This would be caused by an increase of value of money. Firstly, it could hurt spending as consumers will be incentivised to save lots of money because their value will increase overtime. However 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 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 the most is DEBT!!. In a deflationary environment debt can be a real burden since it will only get bigger as time passes. Because our economies are based on debt you can imagine exactly what will function as consequences of deflation.
So in summary, inflation is growth friendly but is founded on debt. Therefore the future generations can 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 afford slow growth).
OK so how all of this fits with bitcoins?
Well, bitcoins are made 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. We now have all seen what the results of deflation are. However, in a bitcoin-based future it could still be easy for businesses to thrive. Bitcoin Evolution 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 want by issuing shares of their company. This could be an interesting alternative as it will offer many investment opportunities and the wealth generated will undoubtedly be distributed more evenly among people. However, simply for clarity, I have to say that section of the costs of borrowing capital will undoubtedly be reduced under bitcoins as the fees would be extremely low and there will not be intermediaries between transactions (banks rip people off, both borrowers and lenders). This might buffer a number of the negative sides of deflation. Nevertheless, bitcoins 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.