The Virtues Of Inflation: How “Generation Debt” could benefit from an expansionary monetary policy

By   /   May 14, 2015  /   21 Comments

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It’s been so drummed into us that inflation is a bad thing, that it’s now quite difficult to grasp how much help inflation can be to those who (like just about all of us) are required to borrow large sums of money.

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IN 1969, my dad took everything he owned and everything he could borrow and invested it all in a house. It was a bloody nice house and a wonderful family home, and, thanks to the high inflation of the 1970s, my dad had no problem paying off the mortgage. It’s been so drummed into us that inflation is a bad thing, that it’s now quite difficult to grasp how much help inflation can be to those who (like just about all of us) are required to borrow large sums of money.

The reason is simple. A steady rate of inflation means that with every passing year one gets to repay the nominal sum borrowed with dollars that are worth less and less.

This is most easily illustrated under conditions of hyperinflation. The most famous example of hyperinflation occurred in Germany in the years immediately following World War I. Military defeat, political instability and economic collapse saw the hitherto stable German Mark plummet in value until it was, quite literally, worth less than the paper it was printed on.

Those who had lent money were wiped out. Debts amounting to millions of marks could be repaid with a single banknote – a banknote whose purchasing power was less than a loaf of bread. The German middle-class, which had made a great virtue out of building up its savings, was also wiped out. Before the inflation, having a hundred thousand marks in the bank meant you were well-off. In the midst of the hyperinflation, a hundred thousand marks wouldn’t buy you breakfast. By the end, middle-class households were paying their servants a billion marks a week!

And that was the rub. Those who had jobs and debts – but very little else – emerged from the hyperinflation more-or-less unscathed. Yes, there had been the inconvenience of having to carry around enormous wads of paper money, but that was more than offset by being able to repay one’s creditors without effort. So, when the German government was, finally, forced to issue a new currency, and the old, now worthless, banknotes were used to fire the factory boiler, Germany’s working-class – who were not great moneylenders, and had no savings to speak of, found themselves in roughly the same position on the social hierarchy as before. Germany’s ruined middle-class, however, discovered they were no better off than the family of a common labourer. Not surprisingly, they blamed and hated the “progressive” German state that had overseen their social disgrace. When Hitler’s Nazis promised to destroy it, the German middle-class was only too happy to supply them with the necessary votes.

Clearly, different social classes experience inflation in very different ways. For those on fixed incomes, rising prices can only lead to a steady decline in their standard of living. If, however, one’s income is regularly adjusted to keep pace with the rising cost of living – as happened in the days of powerful trade unions – the worst effects of inflation can be ameliorated. Moreover, if thousands of people’s mortgage repayments are made easier by inflation, then the virtues of forcing it out of the economy are far from clear.

To those trying to live off an inheritance, or some form of annuity, however, tackling inflation soon becomes an urgent necessity. This is equally true for the banks and financial institutions, to whom inflation holds out the grim prospect of imposing a negative rate-of-return on their lending and investments. And this is precisely what happened in the 1970s, when governments, keen to retain the support of wage and salary earners busily paying off their mortgages, kept interest rates artificially low.

Thinking about inflation as a reflection of class power, it’s a lot easier to make sense of the dramatic shifts in monetary policy that have characterised the last 30 years. If the wealthy (who else lives off inherited money, annuities and “coupon-clipping”?) and the wider financial sector were not suffer the fate of the German middle-class (albeit in slow motion) then inflation would have to be driven out of the economy. That would entail removing the control of monetary policy from politicians and vesting it in the central bank. It would mean destroying the capacity of trade unions to secure automatic cost of living adjustments. Most of all, it would entail making people’s debts real – so that those who lent them money were guaranteed a positive rate-of-return.

My dad’s generation did well out of inflation. And my own generation is doing well out of the scarcities engendered by the measures adopted to drive inflation out of the economy. For the younger generation, however, for whom debt is all-too-real, and from whom scarcity is demanding the surrender of the hopes and dreams their parents took for granted, the virtues of inflation remain to be rediscovered.

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21 Comments

  1. Mike the Lefty says:

    Many economists say that a small steady rate of inflation is the best situation for an economy. High inflation or even deflation is the problem. If there is no inflation, values of things do not rise, therefore people tend not to invest because the returns are low When people don’t invest there isn’t enough money to borrow. Some also claim that zero inflation or deflation create goods shortages.
    If there is high inflation, it puts pressure on wages and is hard particularly on low income earners.
    I remember when, as a child, I first learned about politics and was introduced to the Wairarapa candidates for the 1975 elections. The Labour candidate Jack Williams was asked if inflation was too high. He replied that a certain amount of inflation is necessary, if we get it wrong then its all wrong.
    He was right, but the third Labour government were not successful in halting galloping inflation at that time, due in part to the first oil shocks.
    But we should be wary of those who advocate higher inflation – the people that do best from high inflation are the speculators.
    I recall that the Kirk government introduced a kind of building speculation tax to try and combat the free-for-all lolly scramble that is also called the Auckland housing market. I don’t think it worked too well either.

  2. Janice says:

    The worth of a dollar. Pretty hard to establish!

  3. mikesh says:

    The trouble is we’ve structured our economies in such a way that we have to spend in order to provide full employment. Pretty weird, huh? We spend in order to work! If this were not the case even deflation would be OK.

  4. stooge alert says:

    High inflation causes the transfer of wealth from those who try to save and invest to those who borrow.

    The people who benefit the most are the financial savy and the rich who can see it coming. They move their assets to non-productive assets, like real estate and gold. In Venezuela, toilet paper and sanitary pads are now luxury items.

    Those that suffer are the poor, elderly and the middle classes.
    Initially, prices increases but wages and salaries don’t seem to ever keep up with inflation.
    The elderly who saved for their retirement; their savings are wiped out. The financially connected are the ones able to borrow at fantastic rates from savers who basically give their money away.

    Some may say it is immoral to deliberately aim for high inflation.

    The main reason for high inflation, is that governments buy votes with money they don’t have. So they print it.

    If you think high inflation is good, look at Argentina and Venezuela now. Russia at the time of Yeltsin and the Weimar republic in Germany. That has led to Putin and Hilter……… People lose faith in democracy and want a strongman to fix the problems.

    • Draco T Bastard says:

      The main reason for high inflation, is that governments buy votes with money they don’t have. So they print it.

      Wrong. The reason why we have high inflation is because the privately owned banks create lots of money.

      The governments should create money and spend it into the economy and then tax it out so as to prevent hyperinflation.

      • stooge alert says:

        Venezuela, Argentina and Zimbabwe’s high inflation problems are caused by private banks? They barely have a functional private banking sector. Those governments have very been keen to confiscate private wealth.

        The financial centres of UK, Germany and USA must be suffering from terrible inflation Draco.

        Common sense, not so common.

  5. Draco T Bastard says:

    This is equally true for the banks and financial institutions, to whom inflation holds out the grim prospect of imposing a negative rate-of-return on their lending and investments.

    Loaning out money should, in the normal course of events, result in the entity loaning out the money having less money. This is the nature of the risk of loaning out money – you’re taking the risk that you’re not going to get it back.

    Essentially risk is on a band from 0 (no risk) to 1 (total risk). If you don’t loan it out you get to keep it but if you loan it out you’re into the realm of chances. There’s a chance that you’ll get it back, a chance that you’ll get back even more and a chance that you’ll lose everything. The average should be that you run at a loss.

    I’m sure that the banks understand this which is why they demand to be able to create money when they make loans. If they create the money that they loan out then they’re guaranteed an income from interest as they can’t actually lose the money that they have on hand and a default can easily be written off.

    • Nitrium Nitrium says:

      No one lends out money at an intentional loss. NO ONE. This is why inflation, under normal circumstances, ALWAYS comes with an interest rate that at a minimum keeps up with said inflation. If you think you can maintain high inflation AND low interest rates, you’re dreaming. Credit markets will completely seize up, and you end up doing far more damage to your economy than whatever benefit such a proposal would bring. The MMT folks never cease to amaze me in thinking there is some way to get the proverbial “free lunch” when it comes to economic policy… a policy that by definition must defy the very LAWS of both mathematics and logic.

      • Draco T Bastard says:

        No one lends out money at an intentional loss. NO ONE.

        I didn’t say that they did. I said it is the normal result of risk taking.

        This is why inflation, under normal circumstances, ALWAYS comes with an interest rate that at a minimum keeps up with said inflation.

        That’s because people have come to expect that their savings will maintain their value rather than decrease over time as they should do.

        If you think you can maintain high inflation AND low interest rates, you’re dreaming.

        Two points:

        1. Interest rates should be zero. You are not entitled to have an income just because you have money. That’s bludging.
        2. Economic hypothesis holds that low interest rates leads to high inflation

        Credit markets will completely seize up…

        As long as the government loans out money it doesn’t matter if individuals loan out money or not.

        The MMT folks never cease to amaze me in thinking there is some way to get the proverbial “free lunch” when it comes to economic policy… a policy that by definition must defy the very LAWS of both mathematics and logic.

        LOL

        The present economic hypothesis is the one that fails on those two counts as well also being based entirely upon logical fallacy.

        • Andrea says:

          “You are not entitled to have an income just because you have money.”

          Let’s try that as “You are not entitled to have anything – unless you can persuade others that it is your mutual interest to have it so.”

          “And, if you aren’t important enough, expect to be lied to, cheated, and left in penury for the dubious benefit of a few.”

          The game, sir, is rigged. Always has been. And mitigation of the harms thus caused doesn’t last for long.

          “That’s because people have come to expect that their savings will maintain their value rather than decrease over time as they should do.” Then it’s time for a conversation with that delightful entity known as the Retirement Commissioner who urges, implores, and guilt-trips the citizens to ‘save for their retirement because we can’t afford pensions, or keeping older people in work.’

          I was not aware that ‘trusting’ and ‘self-reliance’ were synonymous with ‘bludging’.

          If they aren’t – then the story above needs the fine hand of an editor and a little less belief (should) and assumption.

          • Draco T Bastard says:

            Andrea, that’s essentially meaningless drivel. It’s all over the place and fails to have a point.

        • Nitrium Nitrium says:

          @DRACO T BASTARD I just want to get your viewpoint completely straight.
          In your economic utopia, there are no mortgages, no bonds, and no financing of any kind (e.g. houses, cars, dishwashers, computers etc) outside of the government itself? The government should simply loan you money for anything you don’t have the cash for by printing it out of thin air at a 0% interest rate? If you have an idea for a new business the Government should just loan you whatever you need to set it up at 0%? Why would anyone EVER consider paying back such a loan when the cost of keeping it is literally 0%? Or do you think no one should be able to purchase anything without having the money to do so? So if you need a car to get to your new job, but can’t afford one, too bad.
          Are you taking into account that every single dollar that is created out of thin air INSTANTLY lowers the purchasing power of all other dollars in existence since said dollars are IMMEDIATELY spent in the economy and are chasing the exact same number of goods and services (and thus effectively act as a tax on everyone)? You don’t foresee rampant inflation or complete stagnation (assuming the government doesn’t just create infinite money for vanity projects) being an unassailable problem in such a scenario?

          • Draco T Bastard says:

            In your economic utopia, there are no mortgages, no bonds, and no financing of any kind (e.g. houses, cars, dishwashers, computers etc) outside of the government itself?

            No, I’d expect minor consumer items to, maybe, be able to get private loans. But for everything else that’s actually utilising the states resources? Nope.

            If you have an idea for a new business the Government should just loan you whatever you need to set it up at 0%?

            Nope. I’d expect the government to require you to have a decent business plan that included paying it back before they extended you the loan.

            Why would anyone EVER consider paying back such a loan when the cost of keeping it is literally 0%?

            Because there’s consequences to not paying it back?

            Are you taking into account that every single dollar that is created out of thin air INSTANTLY lowers the purchasing power of all other dollars in existence since said dollars are IMMEDIATELY spent in the economy and are chasing the exact same number of goods and services (and thus effectively act as a tax on everyone)?

            Yes I am which is why I’m sure that private banks should immediately be prevented from creating money as they do.

            You don’t foresee rampant inflation or complete stagnation (assuming the government doesn’t just create infinite money for vanity projects) being an unassailable problem in such a scenario?

            Nope because I didn’t say that there’d be infinite money. You did.

  6. Nitrium Nitrium says:

    Unless you’re also advocating high interest rates this is a recipe for disaster. Pension funds and insurance companies simply cannot stay solvent in high inflation AND low interest rate environments since speculative investments (i.e. those that theoretically track inflation such as commodities and stocks) can never be a responsible option for them (due to the associated busts). I could go on, but this very simple, but utterly essential FACT, is all you really need to know that inflation can never be a prudent solution for dealing with excessive debt.

  7. Nick says:

    Every economic setting contributes to the creation of winners and losers. However, it is certain that low inflation has much to do with the growing gap between the 1% and the rest of us. When income from investment is always real, any positive investment will add to your wealth, while low returns from banks (along with fear generated by the crashes recently experienced) force all available capital onto the speculative stocks or, in Auckland, property speculation which add to wealth accumulation.

    What right-wing government worth it’s salt would want to mess with that?

    • stooge alert says:

      I think it is the long-term debt cycle and long-term decrease in interest rates is the cause.
      Lower and lower interest rates result in increasing asset prices. The asset holders benefit.

      The main reason for the secular disinflation despite central banks printing money from time to time has been the greatest poverty action program the world has ever seen.

      Billions of workers in the developing world; China and Asia have come into the world economy. They are no longer living at the subsidence level and producing goods at relatively cheaper and cheaper prices. Bad for unionised workers in developed countries but it has resulted in the greatest wealth equalization the world has seen.
      But in western countries the wealth inequalities has progressively become more acute as the poor compete with better educated, motivated workers from developing countries and the rich are immune from such competition.

  8. Mike in Auckland says:

    Good grief, now we are promoting inflation to resolve the issues of the underclass, are we? Inflation can have different causes, and in the post WW1 Germany it was simply printing money that led to inflation, as that was means for the German government to get rid of suffocating reparations payments, that the Versailles victor nations forced upon the nations that lost the war.

    It did hardly do the average poor person any good, as most were never able to borrow much as poor people, so it was actually some heavily leveraged rich and also middle class people that benefited, some but not most.

    In my very young years I actually even met some people who lived in that time and place, and the stories sounded bizarre to horrendous, where money was losing so much value in the day, you had to instantly spend your pay (if you got any pay) to ensure you got at least something for it. It was the extreme inflation, soon followed by the Great Depression, that led to people losing all trust in the establishment, the banks and economic system of those times, and to Hitler and the Nazis being voted into power.

    Moderate inflation is normal and acceptable, but once it goes above 3 or 4 percent, it can reach danger levels, same as deflation is posing great risks to any economy.

    I rather see more equality and economic and social reforms achieved by other means, not desperate inflation, which will lead to instability for all. And the rich and wealthy will always win, as they have the expert knowledge and advice, and means, to see themselves through inflationary or other problem times.

    Let us start with more equal pay, with real social housing, with free education, and higher taxes for those earning high incomes. We once had such times, in the 1950s, 1960s and still the 1970s, where the bosses and managers did not earn all that much more than the average worker, believe it or not.

    • Liberal Realist says:

      “Let us start with more equal pay, with real social housing, with free education, and higher taxes for those earning high incomes. We once had such times, in the 1950s, 1960s and still the 1970s, where the bosses and managers did not earn all that much more than the average worker, believe it or not.”

      Whilst I agree with most of what you say here I have to disagree with taxing ‘high earners’. Sure we should have a rate of 45-50 % on income over a certain point, not the current 33%.

      The real gains lay in forcing corporations & multinationals to actually pay their fair share. Tax the hell out of dirty industry (see dairy farming) that’s killing the very things that support it (pasture, rivers etc). Tax speculation & movement of large amounts of money using a FTT (Financial Transaction Tax) & ditch GST.

      Tax wealth, don’t place all of the burden on salary earners.

    • wild katipo says:

      Basic Keynesian economics is what brought that about. As it did the Labour policy of public works, housing etc…in response to the Laissez faire policys that helped to cause the Great Depression.


 
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