Inflation, Debt, Wealth - McArdle

McArdle writes:

And I cannot disagree too strongly with the notion that the US can't default because we can always print money.  It isn't even technically true--Zimbabwe eventually ran out of hard currency to buy the ink it needed to print the money to sustain its hyperinflation.

 

Moreover, the dismissive way that Galbraith treats this problem looks only at the stock of debt, not the flow of funds.  Inflation is only a good way to get out of your debts if you aren't planning to borrow any more money.  Otherwise, investors simply recover their losses--and then some--by requiring higher interest rates on all your new borrowing.  "All your new borrowing" eventually includes all of the money you borrowed before, because unless you're running a surplus, you're going to have to roll over every penny of that old debt into new loans as it matures.

Inflation was a good way to ease the burden of our World War II borrowing--once the war was over.  But it is not a good way to ease the burden of an increasingly expensive entitlement program that shows no signs of winding down.

 

You can pull all sorts of tricks to force bondholders to eat some losses on the money they lent you--but you can't pull them over and over.  America was able to wriggle its way out of a substantial portion of its WWII debts in large part because it was otherwise pretty fiscally sound.

Debt held by the public is in the range of $9 trillion, or about 64% of GDP.  The average maturity of our public debt holdings is under 5 years, meaning that roughly half of our debt will have to be rolled over within that time frame.  You can see how short-lived our ability to inflate away our debt would be--and how quickly the budget could be severely compromised by higher interest costs, even if we are using our "means of production" to the hilt.  

 

You can argue that a small amount of inflation is preferable to the alternatives, distributing the pain very broadly in order to avoid the intense dislocations of a sudden shock.  I might even agree with someone who argued this. But small amounts of inflation are not going to rid us of $10 trillion in debt.  And the pain of large amounts of inflation is extremely painful--arguably, more so, not less so, than technical default.

Indeed, in large amounts, inflation is just default by another name.  And it retains many of the problems of default.  Either way, we'll be forced to suddenly slam on the brakes of our deficit finance--either because no one will lend to us, or because the higher interest rates they demand will make such borrowing impractical.  (Just look at Ireland).