Here’s Who Loves Inflation

Government officials say all the right things about inflation, and how they’re trying to combat it. But secretly, they’re not that upset about inflation.

Why? Because inflation makes debt much easier to bear. For a government with over $31 trillion of debt, it can use all the help it can get.

Let’s see how we got here…

The U.S. government bond market was invented by Alexander Hamilton early in the first administration of George Washington around 1790. The newly formed United States of America was facing claims from creditors who had financed the Revolutionary War.

The Congress had a simple solution: Default! That’s the American Way. But Hamilton had a better idea.

He said the new government should borrow more money and use that to pay off the old creditors. Once we did that, we would be deemed creditworthy and we could borrow even more money to pay off the money borrowed in the first round.

This plan was so successful that the U.S. Treasury market has been around for 230 years. That’s how long the U.S. has been borrowing new money to pay off old debt.

In 1835, Andrew Jackson became the first and only president who cut the national debt to zero.

Inflation Is the Only Way Out

The story of U.S. debt is not one in which the debt went up steadily for 230 years. The actual history is that the debt went up in times of war and it was paid back in times of peace.

Debt went up in the War of 1812, the Mexican-American War of 1846–1848, the Civil War, World War I, World War II, Korea, Vietnam and under Reagan to win the Cold War. (The only major debt increase without war prior to 2000 was during the Great Depression.)

But the war debt was paid off during times of peace including the 1820s, 1870s, 1920s and 1990s. It was only after 2000 that things went off the rails and government debt went straight up under George W. Bush, Barack Obama, Donald Trump and Joe Biden.

Now the debt is unmanageable without inflation. Inflation favors debtors because they get to pay back the debt with depreciating dollars. It’s easier to pay down debt because you’re paying back debt with dollars that are less valuable than when you originally borrowed them. So inflation eases the real value of debt.

On the other hand, deflation increases the real value of debt. With deflation, the value of money increases, making it more burdensome to pay off debt. This is why debtors hate deflation.

The other way to deal with the debt is to default. But there’s no reason for the U.S. to default because the debt is in dollars and we can print the dollars.

That’s the great advantage of having the world’s leading reserve currency, what French Finance Minister Valéry Giscard d’Estaing termed the “exorbitant privilege” in the 1960s.

The Debt Death Trap

People who say, “We can’t pay off the national debt!” don’t understand this market. There’s no need to pay off the national debt. We just have to keep rolling it over. But to do that we need to maintain our credit standing, as Hamilton understood. Once our credit is called into question, the entire house of cards collapses.

This shows up first in higher interest rates, then in a devaluation of the dollar and finally in illiquid markets where the debt just can’t be sold except to the Fed. The final stage is hyperinflation and complete collapse of the currency and the bonds.

It’s not going to happen tomorrow, but we’re getting closer to that endgame than many realize.

I’ve said before that the U.S. is caught in a debt death trap. Monetary policy won’t get us out because the velocity of money, the rate at which money changes hands, is dropping.

Printing more money alone will not change that.

Fiscal policy won’t work either because of high debt ratios. At current debt-to-GDP ratios, each additional dollar spent yields less than a dollar of growth. But because it must be borrowed, it does add a dollar to the debt. Debt becomes an actual drag on growth.

The ratio gets higher and the situation grows more desperate. The economy barely grows at all while the debt mounts. You basically become Japan.

The national debt is $31.5 trillion. A $31.5 trillion debt would not be a serious issue if we had a $50 trillion economy.

But we don’t have a $50 trillion economy. We have about a $23 trillion economy, which means our debt is bigger than our economy. And it’s stalling.

Is It a Recession Yet?

We’ve already had two consecutive quarters of negative GDP growth, which is the textbook definition of recession. Now we’re facing the real possibility of a third quarter of negative growth. The Federal Reserve Bank of Atlanta has published its estimate for third-quarter growth using the data we have so far.

The result is a forecast of 0.5% GDP growth, down from 1.3% last week. Don’t be surprised if it goes down even further, or that third-quarter GDP will be negative.

What would the recession-deniers say then?

Now the Fed is preparing to raise rates again this coming week. The hot August inflation data means the Fed will make another aggressive move, probably 75 basis points. But the Fed is tightening into weakness, which it’ll discover once it’s too late.

Heading for a Sovereign Debt Crisis

In basic terms, in the bigger picture, the United States is going broke. We’re heading for a sovereign debt crisis.

I don’t say that for effect. I’m not looking to scare people or to make a splash. That’s just an honest assessment based on the numbers.

Tax cuts won’t bring us out of it; neither can structural changes to the economy. Both would help if done properly, but the problem is simply far too large. You can’t grow yourself out of this kind of debt.

So an economic time bomb is ticking. Velocity is dropping. Debt is growing while growth is slowing. The explosion will come in the form of asset bubbles bursting and stocks crashing, which is already underway.

There’s no way out of the debt death trap except through inflation. And that’s why they’re not as upset about inflation as they’d like you to believe.