Recently I started investing in 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 ways to trade value and the most practical way to do it would be to link it with money. In the past it worked quite well as the money that was 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 is not what is giving value to money but promises. As possible guess it’s very an easy task to abuse to such power and certainly the major central banks are not renouncing to do so. Because of this they’re printing money, so in other words 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 will probably be worth less, whoever is selling something has to 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 offer you is that by de-valuing their currency they are helping the exports.
In fairness, in our global economy that is true. However, that is not the only real reason. By issuing fresh money we can afford to pay back the debts we had, quite simply we make new debts to pay the old ones. But that’s not only it, by de-valuing our currencies we are 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 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 cash 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 how our economies are working, based on inflation and debts.
What about deflation? Well this is often the opposite of inflation in fact 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. To start with, it could hurt spending as consumers will be incentivised to save lots of money because their value increase overtime. On the other hand merchants will undoubtedly be under constant pressure. They will have to sell their goods quick otherwise they will lose money as the price they will charge for his or her services will drop as time passes. But when 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 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 are based on debt you can imagine what will function as consequences of deflation.
So to summarize, 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 might be possible to cover slow growth).
OK so how all this fits with bitcoins?
Well, bitcoins are designed to be an alternative for the money and to be both a store of value and a mean for trading goods. They’re limited in number and we will never have 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 could 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 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, simply for clarity, I must say that the main costs of borrowing capital will undoubtedly be reduced under bitcoins because the fees would be extremely low and there won’t be intermediaries between transactions (banks rip people off, both borrowers and lenders). This might buffer some of the negative sides of deflation. Nevertheless, worldoftechnicalanalysis.com 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.