WHAT’S 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 however, not lots of people actually know and think about what inflation and deflation are. But let’s focus on inflation.

We always needed ways to trade value and probably the most practical way to take action would be to link it with money. Before Bitcoin Revolution worked quite well because the money that was issued was associated with gold. So every central bank needed enough gold to cover back all the money it issued. However, in the past century this changed and gold is not what is giving value to money but promises. Since you can guess it’s very easy to abuse to such power and certainly the major central banks are not renouncing to do so. For this reason they’re printing money, so put simply they’re “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, this 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’re 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 pay back the debts we had, basically we make new debts to pay the old ones. But that is 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 what are the consequences of all this? It’s hard to store wealth. So if you keep the money (you worked hard to get) in your bank account you’re actually losing wealth because your money is de-valuing pretty quickly.

Because each central bank has an inflation target at around 2% we can 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 in fact it is the biggest nightmare for the central banks, let’s see why. Basically, we have deflation when overall the prices of goods fall. This would be caused by a rise of value of money. Firstly, it would hurt spending as consumers will be incentivised to save money because their value increase overtime. On the other hand merchants will undoubtedly be under constant pressure. They’ll have to sell their goods quick otherwise they’ll lose money as the price they will charge for his or her services will drop over time. 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 are based on debt you can imagine exactly what will function as consequences of deflation.

So to summarize, inflation is growth friendly but is founded on debt. Which means future generations can pay our debts. Deflation however makes growth harder nonetheless it means that future generations won’t have much debt to cover (in such context it will be possible to afford slow growth).

OK so how all this fits with bitcoins?

Well, bitcoins are designed to be an alternative for money and to be both a store of value and a mean for trading goods. They are limited in number and we will never have a lot more than 21 million bitcoins around. Therefore they’re designed to be deflationary. We now have all seen what the consequences of deflation are. However, in a bitcoin-based future it could 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. In fact, because contracting debts in bitcoins would be very expensive business can still have 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 section of the costs of borrowing capital will be reduced under bitcoins because 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 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 the past generations.