Recently worldoftechnicalanalysis.com started investing in bitcoins and I’ve heard a great deal of discusses inflation and deflation however, not many people actually know and consider what inflation and deflation are. But let’s focus on inflation.
We always needed a way to trade value and the most practical way to take action would be to link it with money. Before 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 pay back all the money it issued. However, in past times century this changed and gold is not what is 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. For this reason they are printing money, so in other words they are “creating wealth” out of thin air without really having it. This technique not merely 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, that is called inflation. But what’s behind the 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 this is true. However, that is not the only reason. By issuing fresh money we are able to afford to cover back the debts we had, put simply we make new debts to cover 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 carefully the money (you worked hard to get) in your money you’re actually losing wealth because your cash is de-valuing pretty quickly.
Because each central bank comes with an inflation target at around 2% we can well say that keeping money costs most of us at least 2% each 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 prices of goods fall. This might be caused by an increase of value of money. To begin with, it would hurt spending as consumers will be incentivised to save money because their value will increase overtime. On the other hand merchants will be under constant pressure. They will need to sell their goods quick otherwise they will lose money as the price they will charge for their services will drop as time passes. 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 probably the most is DEBT!!. In a deflationary environment debt will become a real burden as it will only get bigger over time. Because our economies are based on debt you can imagine exactly what will be the consequences of deflation.
So to conclude, inflation is growth friendly but is based on debt. Which means future generations can 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 afford slow growth).
OK so how all of this fits with bitcoins?
Well, bitcoins are designed 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 a lot 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 could still be possible for businesses to thrive. The ideal solution will be to switch from a debt-based economy to a share-based economy. In fact, because contracting debts in bitcoins will 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 you many investment opportunities and the wealth generated will undoubtedly be distributed more evenly among people. However, simply for clarity, I must say that area of the costs of borrowing capital will be reduced under bitcoins as the fees would be extremely low and there won’t be intermediaries between transactions (banks rip people off, both borrowers and lenders). This would 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 people inherited from the past generations.