Trying to Inflate Our Way Out of Debt Is Like a Monkey Trying To Outrun a Lion → Washingtons Blog
Trying to Inflate Our Way Out of Debt Is Like a Monkey Trying To Outrun a Lion - Washingtons Blog

Friday, August 28, 2009

Trying to Inflate Our Way Out of Debt Is Like a Monkey Trying To Outrun a Lion

Commonly-accepted wisdom says that we can inflate our way out of our debt crisis.

Ben Bernanke and Paul Krugman apparently think we should force inflation on the economy. University of Oregon economics professor Tim Duy thinks the U.S. will ultimately try to inflate its way out of debt.

Warren Buffet says:
A country that continuously expands its debt as a percentage of GDP and raises much of the money abroad to finance that, at some point, it’s going to inflate its way out of the burden of that debt.
But as I have previously noted, UBS economist Paul Donovan has demonstrated that governments can't inflate their way out of debt traps, saying:
The problem with the idea of governments inflating their way out of a debt burden is that it does not work. Absent episodes of hyper-inflation, it is a strategy that has never worked.
Megan McArdle points out:
It is a commonplace on the right that we're going to have enormous inflation, not because Ben Bernanke will make an error in the timing of withdrawing liquidity, but because the government is going to try to print its way out of all this debt.

Joe Weisenthal notes that it doesn't quite work this way:

As this chart shows, instances of declining debt-to-GDP rarely coincide with periods of inflation. If it did If it did, we'd see more dots in the lower right-hand quadrant.

The bad news for central bankers is that creating currency isn't like, say, diluting shareholders in a company. You're always rolling your debt, and the market's response to an inflationary strategy is (not surprisingly) higher interest rates. It's a treadmill, and it's extremely hard to get ahead.

Inflating your way out of debt works if you're planning to run a pretty sizeable budget surplus--big enough that you won't have to roll your debt over. Otherwise, your debt starts to march upward even faster, as old notes come due, and you have to roll them at ruinous interest rates. Hyperinflation might wipe out that debt, but also your tax base.

Financial Week notes:
Analysis shows even a sizable hike in CPI won't do much for companies or households that owe money.

Analysis released by Leverage World, a publication of debt research firm Garman Research, showed that companies that have issued debt at a coupon rate of 8%, as is typical for non-investment grade issuers, would have to see inflation hit 23% to inflate away the amount of debt they owe in 5.5 years. That’s the average amount of time that investors would have to hold such debt to compensate for the risk of default.

But investors would refuse to do so under such a scenario, Chris Garman, principal in the research firm, noted—not with yields on such debt currently running at 18%.

As Mr. Garman put it in the publication, inflation at that level “would crush the appeal of an 8% coupon.”

And while issuers would have to roll over their debt, they would find it impossible to do so. As he put it in an interview with Financial Week, “They’re staring down the barrel of an 18% coupon.”

Investment grade companies are in better shape. The same can’t be said for other public—or government—borrowers. Indeed, overall debt levels for the private and public sectors now run at roughly 3.5 times nominal GDP. That compares with 1.5 times from 1945 to 1980 and in the early 1920s.

To return to that level, Mr. Garman estimated that inflation would have to rise to around 12% or GDP increase by 75% over the next five years. Either scenario, he said, is hardly likely to materialize.

At a more realistic level of 3% real GDP growth and 2% inflation, Mr. Garman said, it would take 15 years before the overall U.S. debt level fell back under 1.7 times nominal GDP.

“There has been some talk of a rise in inflation as a panacea for distress and default,” he wrote in his report.

His analysis shows that such expectations vastly underestimate what’s required.
Prominent economist Michael Hudson wrote in February:
The United States cannot “inflate its way out of debt,” because this would collapse the dollar and end its dreams of global empire by forcing foreign countries to go their own way. There is too little manufacturing to make the economy more “competitive,” given its high housing costs, transportation, debt and tax overhead. The economy has hit a debt wall and is falling into Negative Equity, where it may remain for as far as the eye can see until there is a debt write-down...

The Obama-Geithner plan to restart the Bubble Economy’s debt growth so as to inflate asset prices by enough to pay off the debt overhang out of new “capital gains” cannot possibly work. But that is the only trick these ponies know...

The global economy is falling into depression, and cannot recover until debts are written down.

Instead of taking steps to do this, the government is doing just the opposite. It is proposing to take bad debts onto the public-sector balance sheet, printing new Treasury bonds to give the banks – bonds whose interest charges will have to be paid by taxing labor and industry...

The economy may be dead by the time saner economic understanding penetrates the public consciousness.

In the mean time, bad private-sector debt will be shifted onto the government’s balance sheet. Interest and amortization currently owed to the banks will be replaced by obligations to the U.S. Treasury. It is paying off the gamblers and billionaires by supporting the value of bank loans, investments and derivative gambles, leaving the Treasury in debt. Taxes will be levied to make up the bad debts with which the government now is stuck. The “real” economy will pay Wall Street – and will be paying for decades.

Wolfgang M√ľnchau writes:

What I hear more and more, both from bankers and from economists, is that the only way to end our financial crisis is through inflation. Their argument is that high inflation would reduce the real level of debt, allowing indebted households and banks to deleverage faster and with less pain...

The advocates of such a strategy are not marginal and cranky academics. They include some of the most influential US economists...

The best outcome would be a simple double-dip recession. A two-year period of moderately high inflation might reduce the real value of debt by some 10 per cent. But there is also a downside. The benefit would be reduced, or possibly eliminated, by higher interest rates payable on loans, higher default rates and a further increase in bad debts. I would be very surprised if the balance of those factors were positive.

In any case, this is not the most likely scenario. A policy to raise inflation could, if successful, trigger serious problems in the bond markets. Inflation is a transfer of wealth from creditors to debtors – essentially from China to the US. A rise in US inflation could easily lead to a pull-out of global investors from US bond markets. This would almost certainly trigger a crash in the dollar’s real effective exchange rate, which in turn would add further inflationary pressure...

The central bank would eventually have to raise nominal rates aggressively to bring back stability. It would end up with the very opposite of what the advocates of a high inflation policy hope for. Real interest rates would not be significantly negative, but extremely positive...

Stimulating inflation is another dirty, quick-fix strategy, like so many of the bank rescue packages currently in operation ... it would solve no problems and create new ones.

And Mike "Mish" Shedlock argues:
Inflationists make two mistakes when it comes to government debt. The first is in assuming government debt is more important than consumer debt. (It will be after consumer debt is defaulted away, but it's not right now.) The second is that it's not so easy to inflate government debt away either...

Inflationists act as if unfunded liability costs and interest on the national debt stay constant. Also ignored is the loss of jobs and rising defaults that will occur while this "inflating away" takes place. Tax receipts will not rise enough to cover rising interest given a state of rampant overcapacity and global wage arbitrage.

Yet in spite of these obvious difficulties, the mantra is repeated day in and day out.

Inflating debt away only stands a chance in an environment where there is a sustainable ability and willingness of consumers and businesses to take on debt, asset prices rise, government spending is controlled, and interest on accumulated debt is not onerous. Those conditions are now severely lacking on every front.
Just as a hungry lion will not leave prey alone unless his hunger is reduced, our massive debt can only be dealt with by starting to pay down the debt.

Instead of trying to outrun the hungry lion, the monkey should (climb a tree) grab any food he can find and start throwing it towards the lion. If he gives the lion enough food, the lion may leave him alone for the time being. And if he gets busy finding food to keep giving the lion, the lion may eventually learn to see him as an ally, instead of a meal, and make sure the monkey is safe.

And as I have previously written, abolishing the central bank and taking over the money and credit creation functions from the private banks may be an important part of the solution to our debt trap. See this and this.


  1. Excellent article. Not so sure if I understand the lion baboon analogy, but I do like the picture.

    This whole idea of washing debt out with inflation doesn't really work. I guess those of us who believe inflation will strike have been trying too hard to get others to understand our point of view and need to let the rotting fruit fall from the tree. When inflation hits, it'll be a "surprise" to everyone but us, who knew it was coming and tried to live within our means, etc..

    The easier approach is to accept the Washington consensus that inflation is preferable to deflation. In nominal terms, rising prices (really a weaker dollar) mean higher tax revenues and corporate profits, at least for some industries.

    Interest rate environment will change with de facto inflation. I say de facto because current inflation statistics--like unemployment--aren't being reported accurately by government.

    Lower inflation reporting allow the government to pay less to borrow--a key consideration considering the quantities of gov't debt being peddled every week.

    Higher interest rates mean big borrowers will be forced to cut back on borrowing, meaning gov't spending will drop, and crowding out will worsen, putting additional stress on corporations' ability to borrow. Private sector investment, unlike gov't, delivers a good multiplier effect. G--gov't spending--is essentially bottomless. Even removing the Fed won't be able to stymie Washington's spending. It's only once the Chinese/Japanese say no.

    We can't have a recovery without jobs. Undercounted, the ranks of the disenfranchised grow. Out of sight out of mind. We saw the same thing during Reagan in the early Eighties.

  2. i wouldn't be quoting << Megan McArdle >> about anything for any reason at any time.

    she is a melon headed tool.

    that is all.

  3. Take a close look at Mugabenomics.

  4. Jct: The economy is short of money but as long as people think inflation is too much money chasing the goods, Shift A, and don't know about the possibility of Shift B inflation, they'll be knocking the solution to their problems.
    See my youtube video "Shift B inflation" if you can't figure it out on your own.

  5. Great contrarian post, thanks.

  6. Inflating your way out of debt can work if you pin down the debt first. That is, if the government unilaterally extends the duration of treasuries during the inflation. Then interest can't rise to match inflation.

  7. Another Reason Why My Doctor Tells Me The Nation Shouldn’t Read Megan McArdle…

  8. Funny, of all the people I would not be quoting, it's Hudson.

    The meme of "China or Japan saying no" is one I am surprised still persists. These two are hardly the only large purchasers, and the meme implies that they (especially the Chinese) are virtually the only purchasers, rather than the reality that the Chinese simply (at most) make borrowing cheaper. (That, and the pervasiveness of The Meme allows other buyers to leverage fears of whether "the Chinese will show up" to game the system.)

  9. Can you do a follow up with Geithner and Bernanke as baboons picking each others butts, picking bugs out of each others fur and eating them. Then,top it all off by having them flick poo at each other?? I'm not sure what it would mean, but I'd like to see their faces on those baboons, etc. :) Maybe one meaning would be to get out of the prehistoric ages - we need to evolve. We need to put some real men in charge - not these backwards a** primates who can't see past themselves and their own interests.

  10. The way out of debt is growth. That's what has happened in many key cases, especially in the US from 1945 - 1960 and elsewhere. That's what Bernanke and Krugman are saying, and if a little inflation comes with the growth, it's worth it.

  11. Any idea what happen to that monkey?

  12. Well, if it's a stupid idea that will end up being counterproductive, then I guess I can count on Obama and his band of tax cheats to try it.

    The economic acumen of the community organizer in chief can be gauged by the bizarre Cash for Clunkers debacle. This has been history's largest and most brazen embrace of the Broken Window Fallacy.

    I suspect the puff of smoke himself never bothered to read any Bastiat, but I'm sure his advisers have. The fact that they decided to go ahead with this risible destruction of real wealth tells me all I need to know about the Obama Administration: They are willing to destroy America, to leave it with not one stone standing upon another, if necessary to bring about the socialist Utopia they have been imagining since their marijuana-fueled dorm-room bull sessions of the 60's.

    The only bright side is that I have a large fixed-rate mortgage and a job that is likely to keep pace with inflation. That may keep me right side up until Obama's third or fourth term, when his armies of commissars and czars begin confiscating private property for their country dachas.

    Nothing to do but await the Revolution, and hope I can take out at least a dozen of the looters and moochers when the Black Maria comes for me. Aux armes, citoyens!

  13. If inflation breaks out no one can say how bad it will get, or how quickly. People simply don't seem to understand this. And if we have reached the point in abstrusive bullshit that permeates our society that people can say with a straight face that government printing is not inflationary (pausing for breath),then let me off at the next stop.

  14. ballyfager, it's already happened, but I doubt they'll let you off this train.

  15. Inflating away debt is how the Vietnam war was paid for. The crime of inflating away debt is that it is the most regressive tax policy around.


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