Inflation is the economic tool of choice for overly indebted governments and their central banks to “extend” worldwide growth and “pretend” that the current global economic environment is sustainable. Hyperinflation occurs when a central bank’s efforts to prop up a currency run out of control. It is an extreme case of inflation and a nightmare for anyone living through it.
The world is drowning in too much debt. That fact is well documented. It is very unlikely that governments will be able to pay down that debt. Doing so in some cases is impossible – the level of debt is just too high (i.e. the United States), and in other cases it will condemn their citizens to many years of painful sacrifice to be debt free.
Inflation, by comparison, is perceived to be the easy way out by government policy makers. Companies and families usually deal with too much debt by defaulting and declaring bankruptcy, while sovereign nations overwhelmingly deal with debt by inflating it away.
That is the true power of a fiat currency. While debt is fixed, the value of a country’s currency is not. Fiat currency, such as the U.S. dollar, will increase and decrease (mostly decrease) in value over time. This decrease in the value of the currency makes that country’s debt burden smaller. Think of it this way – you borrow a dollar from a friend. By the time you pay your friend back that dollar has devalued to 80 cents – you’re ahead of the game. You got the full purchasing power of the dollar you borrowed, but you only had to pay back 80 cents. Pretty good deal huh! Our government does that to you and me every day.
Individuals or companies cannot devalue a currency or increase prices and through inflation, only governments can. And they have become extraordinarily good at it over the years. Inflation and currency debasement are not new. They have been used for the past few thousand years as means to get rid of debt. And in some cases, they work pretty well.
You don’t even have to go that far back to see how high inflation (hyperinflation) works at eliminating debt. Consider Brazil which is one of the world’s most recent examples of hyperinflation. In the late 1980s and 1990s, Brazil successfully inflated away most of its debt.
This is part of the standard inflation playbook. It has even been used successfully in the United States. You may remember that the United States had high inflation in the 1970s and then got a diligent central banker – Paul Volcker, who raised interest rates, produced strong real GDP growth, and set the stage for one of the greatest economic booms in our nations history.
In 1993, Brazilian rate of inflation was roughly 2,000 percent. Only four years later, in 1997 it was seven percent. Almost, as if by magic, the country’s debt disappeared. Today, Brazil has very little debt. Its economy is booming and the country is a success story.
Imagine if the United States increased its money supply, which is currently $960 billion, by a factor of 10,000 times, as Brazil did between 1991 and 1996. We would have more than nine quadrillion U.S. dollars in circulation. That is a lot of zeros. It would mean that our current debt of $14 trillion would be chump change.
You might assume that employing this strategy for getting rid of our debt would have consequences. What sane person would ever lend money to us again? But, think again. Investors have very short memories. Markets always forgive default and inflation. Just look at Brazil, Bolivia, and Russia today. Foreigners are delighted to invest in these countries.
Money printing and monetization of government debt are used when real growth fails. It has worked in countless emerging market economies (Zimbabwe, Ukraine, Tajikistan, Taiwan, Brazil, etc.). We could even use it in the United States to get rid of all our debts. It would take a few years, and it would destroy the accumulated wealth of millions of Americans, but it would eliminate our public debt burden.
After we inflate away our debts, in steps a savior, a new central banker like Paul Volcker to kill inflation. We could then become a success story like Brazil.
I am not recommending sustained inflation or hyperinflation as an economic policy tool. But now even serious economists are recommending inflation as a solution to our debt crisis. High, prolonged inflation would accomplish much of the governments goal of eliminating, or at least, gaining control of its debt. The powerful deflationary forces at work in the world today give Ben Bernanke and the Federal Reserve easy justification for their continued “quantitative easing”.
The International Monetary Fund’s top economist, Olivier Blanchard, has argued that central banks should target a higher inflation rate than they do today to avoid the possibility of deflation. Economists like Paul Krugman, a Nobel Prize winner, and Blanchard argue that central banks should raise their inflation targets to as high as four percent. Paul McCulley argues that central banks should be “responsibly irresponsible.” There are, however, problems with inflation as a policy tool.