September inflation rose 8.2% and core inflation, which excludes food and energy costs, rose 6.6% in a year. Both increases are near the highest rate of inflation in 40 years! Central banks are raising interest rates at record speed in an effort to squash inflation.
But this rapid interest rate policy response raises one important question. If inflation is one way to manage excessive government debt by intentionally decreasing the real value of the debt, why are central banks doing it? It is a fact that in the long-run, inflation is the only way to manage excessive debt burdens assuming the debt is denominated in a currency you do actually print. If not, you simply default on your debt or restructure it.
The U.S. debt is mainly nominated in USD and the Fed prints it. Therefore, there is no need to default. You can just print as much money as you need to pay the debt. Of course, this kind of money printing to pay debt is inflationary. The big question here is why are governments trying to reduce inflation if inflation is the ultimate way out of the debt?
The difference between high inflation and low inflation is very simple: Inflation is an indirect form of stealing money from savers, consumers and these people who earn a fixed income. Here is an example that explains it all:
Imagine a parent has $50 in her purse in small bills. A child wants to take the money out of the wallet to by sweets. The child knows that if it takes all $50 dollars it will be discovered and most-likely punished. Instead, it takes a few bucks in the hope that the parent will not notice. This strategy might work.
But it definitely works with inflation for the governments. If inflation is 8% or 9% everyone notices, people talk about it, the media reports about it and politicians lose elections. But, if inflation is “on target” with just 2-3% then nobody really notices. But,the effect is still harmful to the regular citizen and worker over time. An inflation rate of 2% per year will cut the purchasing power of the dollar by 50% in 36 years and another 50% in further 36 years. So, 75% of your purchasing power is gone in 72 years, less than an average lifetime. But if inflation is 3%, the same 75% reduction in purchasing power takes place in just 48 years!
Of course, as the real value of money is destroyed, so is the real value of the debt. This is the reason why central bankers and politicians are not against inflation at all, as long as it flies “under the radar”. They are good with inflation of 2-3% which will destroy the value of the debt slowly, nearly unnoticed. It just takes time. They are against higher inflation because people notice it and they get caught out of what they are trying to do. People should understand that the current efforts by the Fed to reduce inflation are not eliminating inflation. The real target is to merely reduce it to the point where the regular guy and voters won’t notice.
Sven Franssen