Inflation has its positives, and can help fight your debt

The pandemic caused economies around the world to slump.

Governments reacted by issuing stayat-home orders that caused problems for many as their incomes and livelihoods were destroyed.

Governments spent money like crazy trying to help people weather the Covid storm – but in fact helped create problems with their lockdowns and the fear and panic caused the biggest decline in a hundred years.

Worldwide, we added more than 20% to the debt burden in about 18 months.

It’s not over yet, either, and policymakers have a new panic to worry about – and it could make Covid seem like a cold. While economies are bouncing back on high spending and ultra-low policy rates, debt levels have exploded.

Never have so many central banks had negative real rates.

At present, 52 out of 59 large economies have negative real rates. The message is clear. Your money is losing value in the bank, so spend. The world debt-to-GDP ratio increased to a record high of 290% last year. It did drop back to 280% as the GDPs of many countries bounced back fast, but 280% is far higher than 240% before the pandemic.

Monetary policy normally fights inflation by increasing interest rates, but only a few central banks have done so – most have not.

Some policymakers may have increased their rates, but interest rates are lower than inflation.

The inflation show could get a lot nastier. Remember, inflation takes money away from the salaries of the workers. Negative policy rates with high inflation is the worst destruction of savings known to man.

Already Germans are buying gold while others pursue equity strategies or buy crypto currencies in the hope of preserving wealth. The assets that grow now are more risky as both stocks and bonds are at very high levels.

In my view, high inflation is now the accepted outcome from central bankers as they choose to help lower debt-to-GDP ratios rather than savers who have come to rely on real rates and low inflation. For real-economy firms, planning for expansion is also about to get a lot more difficult as inflation increases.

The old foe looks set to make a comeback. Global GDP growth for this year is forecast at 6% while next year most forecasters see it at around 4.5%. After that forecasts are now 3% and lower.

At first, central bankers said inflation is temporary and would decrease back below targets quickly.

Since then, they have shifted the language to transitionary or ‘a period of mild medium-term’ inflation. Perhaps inflation will fall back a little, but that is no longer assured.

Targeting lower inflation is dead – it was killed by the pandemic. This while the real median country has a policy rate that is now 2.5% below inflation. Higher growth and higher inflation – and we should be increasing rates, but that is not going to happen for a decade or perhaps even two.

Inflation targeting policy is buried so deep because of the debt mess the world is in. Debt at 280% of world GDP tells one the debt service costs are now the most important factor for central bankers.

Individual debt is over $300 trillion or about $39 000 (around R600 000) per person alive.

That is way above world nominal per-capita income. Data for about 31 countries shows the median debt-service-to GDP for the private sector alone is 15.4%. It is increasing even with super-low interest rates.

The real median policy rate is 2.5% below inflation. If it increases, the world debt bubble will explode. That is because if interest rates rise from these ultra-low levels to combat inflation, total private sector debt-servicing-to-GDP will increase.

At 2.5% below inflation central banks would normally raise rates to about 2% or more above inflation. The debt service cost as a percentage of GDP for the typical country by my calculation would increase to about 25-30% of GDP.

The government sector interest-only payments also increase, so one would get a slow but sustained increase in government debt servicing costs too. Suddenly, borrowers would have to double their payments, and that will decrease expenditure by anything up to 20% as they pay back the banks.

Banks will not find new customers, and with the drop in demand, GDP would shrink faster than debt. Houses and cars will not find buyers and the Middle East will be giving away oil for free.

Price deflation is very likely then, which will decrease nominal GDP even more and the debt burden will become even harder to manage. That is the dilemma the world is in now.

Central bankers must know this and therefore the silent agreement is ‘talk inflation down so we can keep rates low’.

The one way to decrease the debt burden is to get inflation rising as it helps increase the world’s nominal GDP.

Say the 2% real growth happens and inflation rises 4%, then nominal GDP increases 6%. Hope the debt level only increases, say, 4%.

– Moneyweb

– Schüssler is an economist and lover of data. He founded private economic research house Economistsdotcoza in 2005.