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Why are all fiat currencies inflationary, and lose value with time? Could governments make them deflationary? What are the advantages of inflationary currency compared with deflationary currency?

Why was Bitcoin chosen to be deflationary (limited number of total coins)?

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There are many causes for inflation, but the two most often agreed upon, according to Investopedia, are these:

Demand-Pull Inflation - This theory can be summarized as "too much money chasing too few goods". In other words, if demand is growing faster than supply, prices will increase. This usually occurs in growing economies.

Cost-Push Inflation - When companies' costs go up, they need to increase prices to maintain their profit margins. Increased costs can include things such as wages, taxes, or increased costs of imports.

Fiat currency inflation absent these forces can be driven by the creation of money through speculative fractional reserve bank lending practices as well as simple "printing of money" by the central bank responsible for a government's currency. It is in the interest of the government's ability to spend that it be able to freely create money out of nothing, which is the veritable definition of fiat, Latin for "let it be".

Advantages of inflation include:

  • Steady rise in prices
  • Steady rise in value of non-liquid assets, e.g. not cash
  • Supposedly an indicator of growth

Disadvantages of inflation include:

  • Cost of goods increases because one unit of money does not have as much purchasing power as it did previously
  • Decrease in the value of stored liquid assets, e.g. cash in a non interest-bearing account
  • Potential for hyperinflation

Bitcoin's deflationary quality is based on the assertion that a currency must have scarcity in order to be valuable. By limiting what amount can enter the system, it ensures that no individual can increase the supply and inflate the value relative to physical goods.

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