We can try to inflate away the government’s debt, but we’ll go broke before succeeding

Summary:  another in a series about the financial condition of the US government.  This is  follow-up post to Why the U.S. cannot inflate its way out of debt (15 March 2010).   We’re in worse shape than most of our peers, and far larger (whales cannot manuever like minnows).   Other posts later this week discuss this important topic.

The Boomers expect inflation; many yearn for it.  Not only will this fix the government’s excess debt, but it will provide another opportunity to get rich.  We experienced inflation during the 1970’s and know how to benefit from it.  Leverage up, buy real estate, gold, and commodities.  Easy money.  Too bad it’s probably a fantasy.

Unexpected inflation is the magic pill of government finance.  It played a major role in evaporating the massive WWII debt, from 108% of GDP in 1946 to 25% in 1975.

Expected inflation is painful, perhaps fatal.  As it might be for the US in the next decade.

  1. The debt is too big — $8.2 trillion and growing fast.  It was only $670 billion in March 1980, at the start of Reagan’s Administration.  See the graphs below for debt/gdp ratios.
  2. The maturity of the debt is too short.  The average maturity is 55 months, vs. 112 months in 1947.  Large deficits and short maturity means that rising rates would rapidly increase the government’s interest costs, so that inflation would hurt — not improve — its solvency.
  3. Over half of the federal budget are officially (Social Security) or unofficially (Medicare, wages) linked to rise with inflation.  In 1946 the budget was little affected by inflation.
  4. There was little precedent for inflation in 1946; it took decades for bond buyers to wake up.  Now we expect inflation, have grown to adulthood during the Great Inflation.  At the first signs of inflation we will protect ourselves by shorting the maturity of bond investments, buying adjustable rate and inflation-adjusted bonds, and real assets.  This rapid adjustment will by itself kill any benefit to the government from inflation.  We saw this in the late 1970’s.   Young lawyers like Hillary Clinton invested in cattle future, and owning long bonds was consider insanity (the average maturity of the federal debt was 21 months in 1776).

The following graphs illustrate important aspects of the problem.  At the end are links to useful articles on this topic.

 (1)  Size of the debt

From Brad DeLong, 11 June 2009.  By debt “truly held by the public”, he means gross debt less Treasury debt held by the Federal Reserve.  That is a larger number than “public debt”, which does not include intragovernmental debt (owed by the right hand to the left).  It’s a good measure for this purpose, as it partially includes the liabilities for Social Security and Medicare.

(2)  Average maturity of the debt

Note the short average maturity in the early 1980’s, when inflation and high interest rates threatened to capsize the government.  A repetition of this today would be lethal for the government’s solvency.  Of course, the Treasury staff see this danger and has issued longer bonds to lengthen the maturity of the public debt from its low of 50 months to 55 as of Q1.  That costs more, but it’s a necessary policy change.  They plan to bring the average maturity up to 70 months, at which point inflation becomes a feasible option (if quietly implemented).  As shown in this graph from the Treasury’s “Quarterly Refunding Charts“, 1 February 2010.  Many experts remain skeptical that the US government can accomplish this. 

For more information about government debt

  1. We cannot inflate our way out of this crisis“, Wolfgang Münchau, columnist for the Financial Times, 24 March 2009
  2. Debtflation“, Spyros Andreopous, Morgan Stanley, 23 October 2010 — The government creating inflation in order to ease the debt burden.
  3. Using Inflation to Erode the U.S. Public Debt“, Joshua Aizenman (Prof Economic, US Santa Clara) and Nancy Marion (Prof Economics, Dartmouth), 18 December 2009 — The full paper is here.
  4. The Return of Debtflation?“, Spyros Andreopous, Morgan Stanley, 12 February 2010
  5. Why Inflation Won’t Solve Our Debt Problems“, blog of the New York Times, 18 February 2010
  6. We Can’t Inflate Our Way Out“, Richard Berner, Morgan Stanley, 23 February 2010
  7. Default or Inflate or…“, Gerard Minack, Morgan Stanley, 25 February 2010 — Another option:  forced purchases of low-interest government bonds.
  8. Dangerous curve – Government-bond markets enter the twilight zone“, The Economist, 31 March 2010

Posts on the FM website about inflation

  1. Is the US Government deliberately underestimating inflation?, 8 November 2007
  2. Death of the post-WWII geopolitical regime, III – death by debt, 8 January 2008 – Origins of the long economic expansion from 1982 to 2006; why the down cycle will be so severe.
  3. A giant breaks his chains and again walks the earth: inflation, 10 June 2008
  4. The geopolitics of inflation, an introduction, 17 June 2008
  5. Consequences of a long, deep recession – part I, 18 June 2008
  6. Debt – the core problem of this financial crisis, which also explains how we got in this mess, 22 October 2008
  7. Inflation or Deflation? Nobody knows what path will we take., 21 July 2009
  8. Beginning of the end of the Republic’s solvency. Soon come the first steps to a reformed regime – or a new regime., 14 August 2009
  9. The falling US dollar – bane or boon?, 14 October 2009
  10. A lesson from the Weimar Republic about balancing the budget, 10 February 2010
  11. Would a default by the US government help America?, 21 February 2010
  12. Can Obama turn America into something like Zimbabwe?, 22 February 2010
  13. The Fed is not wildly printing money, as yet no hyperinflation, we’re not becoming Zimbabwe, 2 March 2010
  14. We might default on our governments’ debt in the future. Do you know how often we’ve done so in the past?, 5 March 2010
  15. Why the U.S. cannot inflate its way out of debt, 15 March 2010
  16. Can Obama turn America into something like Zimbabwe?, 22 March 2010


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