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Inflation Conspiracies January 6, 2010

Posted by federalist in Economic Policy, Finance, Taxation.

If you are a debtor, and your debts are denominated in dollars, then dollar inflation directly benefits you by reducing the real cost of your debt.  So imagine the moral hazard when one of the biggest dollar debtors — our government — happens to have the ability to inflate the dollar!  (Not to mention that, due to our tax code, dollar inflation is itself a tax that increases government revenue.)

Rick Bookstaber notes the political spin on this situation:

Suppose all the Good Guys (Joe Consumer and Homeowner) are loaded with debt, and suppose that this debt is payable to the Bad Guys (Rich People and Foreigners). What can you do about it? Oh, and also suppose that the debt is mostly in nominal terms. Answer: You inflate.

What will happen when politicians realize that they can surreptitiously redistribute wealth from capital owners to both the government and the indebted?  Since this is consistent with our government’s tendencies over the last century you may wonder why it’s not already happening.

For one thing, there is supposed to be a mechanism to prevent this:  The dollar’s supply is regulated by the Federal Reserve, which was supposed to be both (A) independent of the federal government, and (B) interested only in maintaining dollar stability.  However, some time ago they gave up on the latter point, with muddled pronouncements about balancing dollar stability with other economic objectives like employment.  And the last year or so has seen the evaporation of any semblance of Fed independence from the government.

So the institutional barriers that originally secured the dollar’s value are effectively gone.  The only other thing that holds back politically-motivated inflation is the fact that inflation only has the desired effect if it’s unexpected.  If the government came right out and said, “We’re going to 6% annual inflation in order to reduce our debts, increase our revenues, and help all the debtors who vote for us,” it wouldn’t work for long:  Owners of existing dollar-denominated debt would be hurt, but when the government went to expand or rollover its debt it would find lenders demanding annual rates at least 6% higher than they do now.  Likewise with individual borrowers.

In fact, if the dollar was abused too much people would probably stop lending in dollar terms at all: If you wanted a loan, repayment might be demanded in Euros, or barrels of oil, or ounces of bullion.  (Several of my recent investment posts deal with practical means of hedging against dollar inflation.)

And this is where the conspiracy comes in.  Bookstaber explains:

To do inflation right, you have to be a little sneaky. Especially if you don’t want your creditors feeling totally screwed and have them walk away the next time you need to borrow. Don’t announce it as a policy. Have it just happen. In fact, have it happen in spite of all of your best efforts to reign it in. So you need a controlled burn that looks like it is spontaneous. Who knows, maybe this idea actually is making the rounds.

Given the political inclinations of the current establishment it’s not hard to imagine.



1. federalist - May 6, 2010

Randall Holcombe notes:

With the national debt in excess of $12 trillion and deficits projected to fall to under $1 trillion (Wow, it’s hard to write such big numbers!), 10 percent inflation would keep the real value of the debt about the same, or maybe even reduce it a bit.

We’ve done it before, and nobody seemed to complain much. During the 1970s the value of the dollar fell by about half because of inflation, and while people did complain about the inflation, nobody said much about the fact that in effect, by 1980 we defaulted on half the debt we had in 1970.

2. federalist - January 17, 2013

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