Recently Bitcoin Era Site started buying bitcoins and I’ve heard a great deal of discusses inflation and deflation however, not lots of people actually know and think about 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 take action would be to link it with money. In past times 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 of the money it issued. However, during the past century this changed and gold isn’t what’s giving value to money but promises. As 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. That is why they’re printing money, so quite simply they are “creating wealth” out of nothing without really having it. This process not only exposes us to risks of economic collapse but it results also with the de-valuation of money. Therefore, because money is worth less, whoever is selling something must 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 so? Well the answer they might give 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 real reason. By issuing fresh money we can afford to cover 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 are 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 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’re actually losing wealth because your cash is de-valuing pretty quickly.

Because each central bank has an inflation target at around 2% we can 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, predicated on inflation and debts.

What about deflation? Well this is exactly 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 costs of goods fall. This might be caused by a rise of value of money. First of all, 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 will need to sell their goods quick otherwise they will lose money because the price they will charge for their 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 the most is DEBT!!. In a deflationary environment debt will become 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 to summarize, inflation is growth friendly but is based on debt. Which means future generations will pay our debts. Deflation alternatively makes growth harder nonetheless it means that future generations won’t have much debt to pay (in such context it will 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 also 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. We now 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 way to go will be to switch from the debt-based economy to a share-based economy. In fact, because contracting debts in bitcoins would be very expensive business can still have 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 area of the costs of borrowing capital will undoubtedly be reduced under bitcoins as 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 some 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 days gone by generations.

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