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

Recently I started investing in bitcoins and I’ve heard a lot of discusses inflation and deflation but not many people actually know and consider what inflation and deflation are. But let’s start with inflation.

We always needed a method to trade value and probably the most practical way to do it is to link it with money. In the past it worked quite well because the money that was 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 past times century this changed and gold isn’t what’s giving value to money but promises. As possible guess it’s very easy 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 basically they are “creating wealth” out of nothing 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 will probably be worth less, whoever is selling something has to increase 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 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 is not the only real reason. By issuing fresh money we are able to afford to cover back the debts we’d, 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 simpler 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 cash 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 how 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 have deflation when overall the costs of goods fall. This would be caused by an increase of value of money. To begin with, it could hurt spending as consumers will undoubtedly be incentivised to save money because their value increase overtime. Alternatively merchants will undoubtedly be under constant pressure. They will need to sell their goods quick otherwise they will lose money as the price they will charge because of 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 probably the most is DEBT!!. In a deflationary environment debt can be a real burden as it will only get bigger over time. Because our economies derive from 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 however makes growth harder but it means that future generations won’t have much debt to pay (in such context it could be possible to cover slow growth).

OK so how all this fits with bitcoins?

Well, bitcoins are made to be an alternative for the money also to be both a store of value and a mean for trading goods. They’re limited in number and we’ll never have 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. Actually, because contracting debts in bitcoins will be very costly business can still have the capital they need by issuing shares of these company. Bitcoin Revolution could be an interesting 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 the main costs of borrowing capital will undoubtedly be reduced under bitcoins because the fees will be extremely low and there will not be intermediaries between transactions (banks rip people off, both borrowers and lenders). This might buffer a few 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.