This is a subject that I have put significant thought into over the past few months. It seems as if Bitcoin, and other digital currencies, could significantly influence the rate at which fiat currencies experience inflation or deflation. In the US, the Fed is already experiencing difficulty causing the level of inflation they are aiming for, and that ability could be further hampered in the future.
How Can Bitcoin Effect Inflation?
As Bitcoin achieves more mainstream acceptance, and the volatility calms, it is likely that it will once again begin to slowly climb in value over time. At that point, it will quickly become very difficult for any fiat currency to maintain only a slight amount of inflation, as is commonly sought after by economists in certain schools of thought.
Instead, when a currency is manipulated in a way that is expected to cause inflation, it would be in the best interest of the population using that currency to convert their funds into bitcoins, as to avoid having their wealth diluted. However, this may actually have the effect of increasing the inflationary rate of the fiat currency, as such an influx into Bitcoin would quickly drive the price of Bitcoin vs fiat up. The increased purchasing power that Bitcoin would enjoy would have to come from somewhere else, and that place would likely be from the fiat currency being converted into it.
Conversely, if a country’s economy is strong, and it’s currency seems to be resistant to inflation, or if Bitcoin itself is experiencing a downtrend, then a flood of individuals selling Bitcoin could cause the fiat currency to begin to experience deflation. The amount of manipulation it would take for a government, or an institution such as the Federal Reserve, to limit the effects of this could very quickly get out of their control.
Is This Good or Bad for Bitcoin?
While this could be spun to seem like a negative toward Bitcoin, as it would be a destabilizing force in either of these situations, that would be short sighted. If one of these situations were to occur, it would simply be a testament to the pitfalls inherent in a monetary system, such as fiat, that relies on a monopoly to function. I do not expect Bitcoin, or any other digital currency, to ever completely replace traditional currencies. However, I do expect that it will require a higher level of responsibility, and accountability, to be maintained by the managing institutions, and that will be good to everyone.
Of course, this is all dependent on Bitcoin achieving mainstream acceptance, and growing to many times it’s current market cap. That should give economists, and banks, ample time to develop plans to handle any potential situation that may arise. Hopefully this planning is already in progress.
