Inflating away debt?

As this blog shows, we are entering deep doodoo with public-sector debt. And  Left Outside suggests here that the Tories are planning to use inflation to pay it off; which is good news for anyone in debt, but very bad news for anyone who has actual savings denominated in money terms (like bonds, gilts and cash).

The trouble is that this won’t work while we are still running a big current deficit, because inflation will grow the deficit which will grow the debt faster than we can pay it off.

OK, a quick reminder of what we are talking about:

  • the deficit is the amount by which annual income – mainly from taxes – falls short of annual expenditure. In other words, it’s an annual thing;
  • national debt is the total amount the country owes, which increases each year by the amount of the deficit; and
  • the structural deficit is the amount by which the annual deficit exceeds the cyclical deficit: normally, you would expect government accounts to be in surplus during the good years and in deficit in a recession.

This being Government, however, there’s no actual to-the-penny true figure for any  of them. Nor even any to-the-billion true figures.  All the published figures are: (a) largely made-up; and (b) far too small, mainly because they don’t include future liabilities, such as what we’ve already promised to pay in the form of pensions. Or PFI contract payments.  Of the debt, let’s just say that  the country owes a scary amount of money. That is ‘we the people’ owe a lot of other people a stackload of money.  Some of us, as well as sharing in the debt, are also the people who are owed this money because we have some of our savings in gilts and National Savings.

Money, long ago, stopped being related to anything tangible like gold or silver. It’s now nothing more than numbers in a set of networked computers operated by the world’s main financial institutions, including the central banks, that determine how we trade real stuff. And what we are actually talking about is the disposition of these numbers on those computers, which are out of kilter,  because lots of people have been making promises they can’t keep.

  • The governments of the world, including ours, have been making a promise to pay their citizens’ pensions (this is the killer impossible promise);
  • Companies have been making promises to pay their employees’ pensions, and realising they can’t do it;
  • Life offices have been making, or implying,  promises to pay pensions and endowments;
  • Lots of poor people have been making promises to pay back mortgage debts (which cause the sub-prime crisis in 2008);

Very few of these promises can be kept; most of them should never have been made.

As a result of these impossible promises, the financial system is creaking, and the policy debate between the Cleggeron Cutters and the Obamillibandits is about how best to ease the strains without breaking it, because basically the whole of modern civilisation – government and trade as we know it – needs the financial system to keep working.  We’ve seen what happens when it stops working in individual countries like Zimbabwe or Weimar Germany; but if it stopped working across the world?

Controlled inflation – not hyper-inflation –  is actually quite a good tool to sort some of it out. It devalues money, and since most of the problem is with the current distribution of money, just devaluing redistributes it.  Inflation has been used successfully in the past to pay of a lot of government and consumer debts: most of the Baby Boomers had their mortgages paid off by inflation.  This requires negative real interest rates, which we now have. Debt and savings denominated in pounds are losing value. At the moment, real assets such as houses and equities are also losing value, but this is because they were over-valued before and sooner rather than later the tide, in nominal terms at least will turn.  When inflation kicks in properly, equities and property are the only things that hold their value.

It’s not fair on those who lent the government money and keep their savings in gilts, but it’s a risk you take whenever you keep your savings as actual money and in instruments denominated in it, and seriously, if you look at how governments have coped with this kind of mess before, well, what did you expect? So, out of bonds, into property and equities everyone: inflation is coming.  I don’t have to remind you not to put too much of it into property, because if we all do that, no one will be able to afford to pay us any rent.

But none of this will work unless the structural deficit is eliminated first, and this is very difficult, because a lot of it consists of promises we the people can no longer afford to keep (and should never have made in the first place).  Pensions are by far the largest group of these. Now either we break the pension promises we’ve already made to ourselves, or … actually, there is no or. We can’t keep the promises, so they will be broken.  They will be broken sooner or later, and the sooner the better. If I am going to forgo some of my pension, I would rather forgo it at sixty-five (when I hope I’ll still be fit enough to work) than at eighty-five.

Britain is by no means the worst offender for making unkeepable pension promises; most of Europe has made even more impossible ones, and countries like France have not even begun to address the problem politically.  But, for the sake of global financial stability, we’re all going to have to work longer for shorter retirements, inflation or no inflation.


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