Inflation and Black Friday

Planet Money's Adam Davidson has a interesting post comparing Black Friday and inflationary policy decisions.

His basic premise is that the US may have to resort to inflation as an "economic boost". This gets around parliamentary deadlocks around spending increases by simply forcing more money into the economy.

The goal here would be simple (emphasis mine):

With, say, 5 percent inflation — a bit more than double the current rate — $100 today will only buy $95 worth of stuff next year. That's frightening, which is the point. We actually want consumers to realize that prices are rising and that money in their bank accounts is losing value if they don't start spending. The same goes for companies too, which will be compelled to build and hire rather than sit on earnings, as many are now.

It's classic inflation, we steal value from the savers and make them generate more to reclaim that value. Obviously this sucks for people on fixed incomes and people close to retirement who now need a lot more money to retire. But that's frankly a necessary trade-off, we can't afford to give everyone a 20 year retirement on 40 years of work.

Instead let's tackle the two major problems Adam doesn't address:

1. Flight of money.
2. China (and other debtors)

#1: Flight of money

The premise of inflation is that "companies will be compelled to build and hire rather than sit on earnings". But it's not clear that this is really the case. Frankly, companies are already compelled to do this by their investors. If companies felt they could make healthy margins by investing some of their cash, they would be doing that right now.

At best, inflation may encourage companies to invest where they could make "unhealthy" margins. This may put some people to work. But businesses with unhealthy margins generally don't pay very well and they don't tend to be a good store of permanent jobs.

At worst, it would scare companies away from US dollars all together. If companies responded to increased inflation by simply ridding themselves of US dollars, it would increase circulation, but it's not clear that it would actually increase jobs.

#2: China and other debtors

The US has lots of debtors who have been promised a relatively low return on their government bonds.

Let's say you bought a 10 year, 3% government bond in 2006. Target inflation at the time was 2%, so you're expecting to make 1% real return on the bond.

Now it's 2011 and the US Fed says that target inflation is now 5%. All of a sudden, you're losing 3% / year in real value. In fact, that loss for the next 5 years is so big it's going to wipe out all real gains.

Put differently, you gave the US government an ounce of gold in 2006 and it gives you back slightly less than an ounce in 2016. You were expecting slightly more than ounce and you actually got less. The US government actually stole your gold while using it for 10 years.

This is a really terrible and poisonous feeling.

Now imagine that you're China and you have $1,000,000,000,000 in government bonds. Imagine how betrayed you feel now.

Summary

While #1 is not an absolute problem, it's definitely a gamble. However, #2 is a complete show-stopper.

Screwing over your lenders is a great way to kill an economy.