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

Recently I started investing in bitcoins and I’ve heard a great deal of talks about inflation and deflation but not lots of people actually know and consider what inflation and deflation are. But let’s start with inflation.

We always needed a way to trade value and probably the most practical way to do it would be to link it with money. Previously it worked quite well because the money that has been issued was linked to gold. So every central bank had to have enough gold to pay back all of the money it issued. However, in the past 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 are “creating wealth” out of thin air 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 increase the price of goods to reflect their real value, this is called inflation. But what’s behind the money printing? Why are central banks doing this? Well the answer they might give you is that by de-valuing their currency they are helping the exports.

In fairness, in our global economy this is true. However, that’s not the only reason. By issuing fresh money we can afford to pay back the debts we’d, put simply we make new debts to pay 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 better to grow because debts are cheap. But which 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 bank account you are 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 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 exactly the opposite of inflation in fact it is the biggest nightmare for our central banks, let’s see why. Basically, we have deflation when overall the costs of goods fall. This might be caused by a rise of value of money. First of all, it would hurt spending as consumers will be incentivised to save 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’ll 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 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 conclude, inflation is growth friendly but is based on debt. Which means 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 could be possible to cover slow growth).

OK so how all of this fits with bitcoins?

Well, bitcoins 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 a lot more than 21 million bitcoins around. Therefore they’re designed to be deflationary. Now Bitcoin Revolution Official 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 ideal solution will be to switch from the debt-based economy to a share-based economy. In fact, because contracting debts in bitcoins will be very costly business can still obtain the capital they want by issuing shares of their company. This could be an interesting alternative as it will offer you many investment opportunities and the wealth generated will be distributed more evenly among people. However, just for clarity, I have to say that portion of the costs of borrowing capital will be reduced under bitcoins because the fees would be extremely low and there will not 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.