Recently I started buying bitcoins and I’ve heard a lot of talks about inflation and deflation however, not many people actually know and think about 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 is to link it with money. Before it worked quite well as the money that has been issued was linked to gold. So every central bank needed enough gold to cover 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. Because of this they are printing money, so put simply they’re “creating wealth” out of nothing without really having it. This technique not merely 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, 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, inside our global economy this is true. However, that is 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 have been 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 which are the consequences of most this? It’s hard to store wealth. So if you keep carefully the money (you worked hard to obtain) in your bank account 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 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 this is often the opposite of inflation in fact it is the biggest nightmare for the central banks, let’s understand why. Basically, we’ve deflation when overall the prices of goods fall. This might 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 will increase overtime. However merchants will undoubtedly be under constant pressure. They will have to sell their goods quick otherwise they will lose money because the price they will charge for his or her services will drop over time. 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 can be 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. Which means future generations will pay our debts. Deflation on the other hand makes growth harder but it means that future generations won’t have much debt to cover (in such context it might be possible to afford slow growth).
OK so how all this fits with bitcoins?
Well, technical analysis 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 will never have more than 21 million bitcoins around. Therefore they’re 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 ideal solution will be to switch from a debt-based economy to a share-based economy. Actually, because contracting debts in bitcoins would be very costly business can still have the capital they want by issuing shares of their 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 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 might buffer a few 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.