What Is Inflation and Deflation and a Speculation About the Bitcoin Future
Recently I started investing in bitcoin s and I’ve heard a lot of discusses inflation and deflation however, not lots of people actually know and consider what inflation and deflation are. But let’s start with inflation.
We always needed a method to trade value and the most practical way to take action is to link it with money. Previously it worked quite well as the money that has been issued was associated with gold. So every central bank had to have enough gold to cover back all of the money it issued. However, in past times century this changed and gold is not what’s giving value to money but promises. As 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. Because of this they are printing money, so put simply they are “creating wealth” out of thin air without really having it. This technique 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 raise 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 so? Well the answer they would give you is that by de-valuing their currency they’re 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 can afford to cover back the debts we’d, in other words we make new debts to pay the old ones. But that’s 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 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 money 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 our 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 could hurt spending as consumers will undoubtedly be incentivised to save lots of money because their value will increase overtime. Alternatively merchants will undoubtedly be under constant pressure. They will need to sell their goods quick otherwise they’ll lose money as the price they will charge because of 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 will become a real burden since it will only get bigger over time. Because our economies are based on debt you can imagine what will be the consequences of deflation.
So in summary, 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 but it implies that future generations won’t have much debt to cover (in such context it would be possible to cover slow growth).
OK so how all of 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’ll never have more than 21 million bitcoins around. Therefore they are designed to be deflationary. Now we have all seen what the consequences 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. In fact, because contracting debts in bitcoins would be very expensive business can still have the capital they want by issuing shares of these company. This could be an interesting 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 have to say that section of the costs of borrowing capital will be reduced under bitcoins as the fees will 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 cover back the huge debts that we inherited from the past generations.