Debt, no one wants it, most of us have it and we hate it.

Debt has acquired a bad reputation over the years. Its excessive and unstoppable growth worries all of us. Consumer debt has been on the rise due to the low interest rates, specially on car loans and student loans. Ideally, consumer debt could help a student afford an education they normally couldn’t afford and have a better job after graduating. This leads to an upward cycle in the overall economy by having more productive individuals thanks to their education. On the other hand, business debt is seen as a form of investment in a company. This debt can be used to develop or grow a company and even in some cases, to create it. Debt is the easiest and cheapest way of financing a company. Equity is usually costly and risky because there is no assurance of the creation of value by that company and even for successful founders it is cheaper to take on debt than to give up equity in the long run. A graph on investment over time is below:

Gross private investment adjusted for inflation

No more debt experiment

Lets say however that today is a magical day and consumer and investment debt disappears.

Poof!

Banks are not lending anymore, but now you want to create a company, and to fuel investments the money has to come from your individual savings or your family’s savings. Hopefully that’s enough money because there are no more institutions to finance growth. If the funds aren’t enough for your business venture, then the dream of having a company are gone. The other option is to seek investment from external sources. A system must then be created to have people invest their savings where those individuals are incentivized to do so for a greater return instead of remaining with their savings. In other words you will need to know the cost of money in the future, that’s what we currently call interest rates. Interest rates not only help to plan investment but helps to plan for future living expenses.

Bitcoin World

Let’s say that in this World, banks no longer lend money and everything operates on Bitcoin.

Yes! Finally bitcoin.

Lets run the same scenario where you’re looking for money for your company. You ask family and friends but they are not sure on how much of a benefit they are operating in. How much interest rates in bitcoin changes. Specially with the Hodl culture and the network effects on bitcoin, most people would prefer to keep their bitcoin than to spend it even if its for your company. Ultimately, it will be less risky to hold on to bitcoin. The current problem with bitcoin in the economy is it’s fixed supply, adding to the uncertainty of its cost in the future.

Why?

The fixed supply is seen as an advantage for most people, that way debt can’t be created out of thin air. The minuscule problem is that the current economy operates on debt. Growth in the economy is fueled by investments and investments are fuel by debt. This debt is possible due to knowing the target cost of money in the future, interest rates. Interest rates then depend on inflation. Debt helps to create future value making us hopeful of the economy creating more value in the future; psychology plays an important role in current economic system.

The only way of comparing an economy with a fixed supply of money is with the gold standard. The gold standard failed partly because the value of the economy at that time will depend on the amount of gold held,(In the current economy value is created at the rate of debt). Gold being a scare resource, the economy growth then would be peg to gold. That means that value could only be created at the rate in which gold supply increased. Even if aggregate output was created under this system this will lead to other problems. The difference is that under bitcoin, problems could be more severe because value would be more rigid to a supply that could never grow unlike gold. For instance, no one knows how much gold exists in the world and planets/meteors within our reach. However, we all know that there is only 21 million bitcoins and that won’t change. This would create a deflationary spiral because no matter the amount of value that is created such as, the amount of people that are born or the level of employment, the supply will stay the same; making people to hold more causing less purchasing of product, causing less creation of future products in factories, causing laid offs and ultimately income inequality. The Hodlers will be massively rich and the people being born or without much bitcoin will always have a disadvantage. To prevent this scenario we have inflation.

The consensus is that Inflation is bad and interest rates change every year to a target benchmark of 2%. A magic number than no one knows where it came from and was recently established on January of 2012.

The truth is, inflation doesn’t exist in the long run.

Inflation is a lie, inflation is only a place holder for changing prices that in the long run drives income up . In other words, yes things are more expensive but your income grows over time. With a goal of anyone with a bare income, no matter when they were born or enter the economic system, to be able to afford the bare necessities of living. Different from a fixed supply in which entering the economic system at a later point will be an extreme disadvantage.

Household debt Service Payments as a percent of Disposable Personal Income

At the end of the day its crucial to understand that a fixed supply system like bitcoin operating in the current economic system, doesn’t work. The current system has a lot of debt but personal income is overlooked. In the graph above it depicts how household’s debt has become a lower part of the overall income after all their expenses. Debt used properly, fuels investment and growth. No one really knows about the effects of bitcoin working in a different economic system. It is imperative to not only have the overall use of bitcoin in the economy but to understand how this system could be a better economic environment for future generations were growth doesn’t depend on debt.

I hold bitcoin and the idea of a better tomorrow. I also understand that the explanation given makes massive assumptions and that economic theory is not an exact science, but I will be happy to discuss other possible models by changing the assumptions above. In the next Article I will discuss how bitcoin could be introduced in the World economy partially as an exchange mechanism on the current economic system with fiat currencies.