What Is Inflation and Deflation and a Speculation Concerning the Bitcoin Future

Recently I started investing in bitcoins and I’ve heard a great deal of discusses 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 a way to trade value and probably the most practical way to take action is 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 had to have enough gold to cover back all of 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 an easy task to abuse to such power and certainly the major central banks aren’t renouncing to do so. Because of this they’re printing money, so basically they’re “creating wealth” out of thin air without really having it. This process not only exposes us to risks of economic collapse but 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 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 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 simpler to grow because debts are cheap. But what are the consequences of all this? It’s hard to store wealth. If you keep carefully the money (you worked hard to obtain) in your money you are 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 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 often the opposite of inflation and it is the biggest nightmare for our 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. To begin with, it would hurt spending as consumers will undoubtedly be incentivised to save money because their value increase overtime. However merchants will be under constant pressure. They’ll need to sell their goods quick otherwise they’ll lose money as the price they will charge for their services will drop over time. But if there is something we learned in these years is that central banks and governments usually 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 since it will only get bigger over time. 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 based on debt. Therefore the future generations can pay our debts. Deflation however makes growth harder but it implies that future generations won’t have much debt to pay (in such context it would be possible to cover slow growth).

OK so how Bitcoin Era Official of 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’re limited in number and we’ll never have a lot more than 21 million bitcoins around. Therefore they are designed to be deflationary. We now 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. 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 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 portion of the 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 pay back the huge debts that people inherited from days gone by generations.