As civilization progresses, currency has evolved over many generations. From barter trade to gold, from gold to paper currency, and paper currency to fiat, money has evolved.
Supply and demand, not only involve goods and services, the law of supply and demand also include currencies.
Currencies can be inflationary or deflationary depending on its supply. When the supply increases over time, such as the all fiat currencies (eg. US dollar), it is known as in inflationary currency.
When the supply decreases over time (or if the increase is very little to none – in comparison to the increase in population), it is known as deflationary currency.
There are advantages and disadvantages to these two different types of systems.
Let’s start off with what we all understand, inflationary currency – the US dollar. It is known fact that the US dollar is printed more and more every day. The increase in money supply day by day.
In according to the laws of supply and demand, as the number of goods available is constant, more money is required to compete against a limited number of goods. Therefore, when the money supply is increased, we feel the effects of inflation, whereby, goods and services get more and more expensive over time. In fact, what is really going on is because the money has been devalued by over printing of the currency.
This in effect causes people to spend more and save less. As more people understand about money, why would anybody save money to get less in the future? Therefore, inflationary currency encourages consumption.
In addition to that, as there are less people saving money, some people will find ways to use debt to finance their purchases. Over time, more and more money is in circulation, therefore reducing its value.
But with all the increased spending, it has somewhat increase economic consumption, more people spending money to get goods and services. This has an effect of spurring the economy. Everyone feels richer, businesses get higher valuations, asset prices increase, everybody feel the economy is doing great.
But all these effects come in cycles. It’s the creation of the boost and bust in economies. It’s using leverage to gain advantage and also losses get magnified in the other way. When people get heavily into debt and unable to repay their obligations, that’s when everything comes crumbling down.
Every bubble pops. Everyone is not spending money anymore, businesses suffer, asset prices fall. Suddenly, everyone is feeling enslaved into the money system.
In a sense, inflationary money is not really honest money. Why governments can decide who to give the money to, who to bail out and who not to help? Why should governments have the power to reward high risk takers and punish savers?
In a deflationary currency (eg. gold, bitcoin), as money supply stays constant or shrinks, there are more goods and services competing for the limited supply of money. Therefore, the price of products decrease over time with deflationary currency. In other words, the money has increased in value.
With money becoming more valuable over time, people will start to save and hoard money. This encourages people to save more and spend less.
This however does not mean people do not spend at all. Everybody still have to buy needs such as clothing, housing and food. People will be more risk averse and spend wisely.
The true meaning of store of value in a currency comes from deflationary currencies. Over time, someone who saves money will be able to buy even more products in the future as the value of the currency increases.
No doubt, economy progression will not be faster compared to inflationary currency. But people will still invest their money to better improve their lives. People will still spend, but not lavishly, but carefully because people will understand that the money saved today will be worth more in the future.
Deflationary currency is a somewhat more honest currency as nobody can print any amount of money they wish. As an employee who trade his labor for money, he will only spend money on essentials and save money for the future. Because he knows that the act of saving money will improve his life in the future. And with a deflationary currency, the money saved today will be worth more in the future. In comparison to an inflationary currency, money saved today will be worth less in the future.
As people become more careful with risks, knowing that nobody will bail them out if their businesses fail, there will be less boom and busts cycles in comparison to inflationary currencies. Truly profitable businesses will prosper and companies that fail will have to fail. And nobody will bail them out like in an inflationary currency by diluting the value of all money supply to unfairly distribute money to save a failing enterprise.
In summary, inflationary currency encourages risk taking and discourage people to save money. As the value of money decrease over time, people have to find other ways to multiply their money by beating inflation.
Deflationary supply encourages prudent investments and encourage people to save money. As the value of money increase over time, honest hard working people who trade labor and time for money gets rewarded as the value of money increases in the future.