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

Recently I started buying bitcoins and I’ve heard a great deal of talks about inflation and deflation but not many 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. Before it worked quite well because the money that was issued was linked to gold. So every central bank needed enough gold to cover back all the money it issued. However, during the past century this changed and gold isn’t 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 are printing money, so quite simply they’re “creating wealth” out of thin air without really having it. This process not only 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 has to 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 this? Well the answer they might 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 is not the only reason. By issuing fresh money we can afford to pay back the debts we had, quite 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’s why our countries love inflation. In inflationary environments it’s simpler to grow because debts are cheap. But which 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 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% 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 Bitcoin Era 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 prices of goods fall. This would be caused by an increase of value of money. Firstly, 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’ll have to sell their goods quick otherwise they will lose money because 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 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 be the consequences of deflation.

So to conclude, inflation is growth friendly but is based on debt. Therefore the future generations can pay our debts. Deflation alternatively 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 all of this fits with bitcoins?

Well, bitcoins are made 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’re 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 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 will be very expensive business can still have 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 have to say that section of the costs of borrowing capital will 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 would buffer a number 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.