Inflation v Deflation — State Finances

There’s a general belief, and that’s all it will be, that country financing fare better in an inflationary environment than a deflationary one. This perception arises from the transfer of wealth from creditors to the state by means of a devaluation of the currency, which happens with financial inflation, compared with the transfer of wealth from the country to its creditors through deflation. The result is definitely true, even though it’s played down by governments, but it ignores what occurs to both continuing government obligations and finances.

This article looks at this facet of government financing in the longer period, first about the path to eventual currency collapse that governments create for themselves by making sure a continued devaluation of their currencies, and then in a solid currency environment with a positive result, for which there is very good precedent. Here is the second article exposing the fallacies of assumed benefits of inflation over deflation, the first being published here.

While central bankers have convinced themselves, in defiance of normal human behavior, that ingestion is just stimulated by the possibility of higher costs, there may be little doubt the sub-text is the supposed benefits to debtors in industry and for government. In addition, the role of gaining control over interest levels from free markets is to reduce the overall level of interest paid to creditors, further robbing them of the benefits of making their funds readily available to willing borrowers.

All this can be in defiance of the fundamentals behind contract legislation, but the courts do not take that the unbacked state-issued currency of today is no different from the gold-backed currency of yesteryear, nor exactly the same as tomorrow’s further debased currency. Tax on interest is an extra distortion, decreasing net interest received by holders of depreciating currency even more. It is hardly surprising that the savings price drops in an economy characterised by gross and inflation savings, resulting in a relentless expansion of debt, financed by other ways.

These “other ways” are mostly the growth of bank credit, which will be money created simply through book-entry. The cost of creating this money is set by the wholesale money prices, which are in turn set. If they all expand their bank in exactly the same time (also it should be noted that bankers are extremely susceptible to herd instincts), interest rates can theoretically fall to zero, or more nearly, the marginal cost of it, and which on large loans is nearly the same thing. And when that isn’t enough, there is presently in addition a blend of central banks rigging interest levels to be adverse coupled with quantitative easing, that has even allowed corporate debtors to be compensated to borrow money.

As already mentioned, the whole point of monetary inflation is to transfer wealth from bank to borrower. From the government’s case, it’s a substitute for taxes that have become so problematic, it to increase them further either risks tripping a citizens’ rebellion, or can be so economically detrimental that even the state understands to back away. However, the books must be more balanced, and awarded the unpalatable alternative of cutting spending, funding through financial debasement is the approved alternative.

Most central banks understand from experience that if the central bank is involved in financing the government’s paying straight, the currency will eventually descend into crisis. Instead, central banks achieve exactly the same thing by curbing interest rates and enabling the commercial banks to register for government bonds. They are bought by the banks themselves, or alternatively by committing to other people to get the government’s debt. You will find technical financial differences between public and bank subscriptions for government debt, which has to be surrendered. Regardless, it’s at least as inflationary, being supported directly or indirectly with the growth of bank credit, particularly when central banks ensure that total currency in circulation will never be allowed to contract.

An important premise for long-term inflation goals, currently set at 2% per annum, is that the overall price level could be controlled by handling the currency stock. This flies in the face of all encounter, and even economic theory. Throughout the Volcker chairmanship of the Fed, once the effective Fed funds rate climbed to over 19 percent, there wasn’t any let-up in the growth of huge money. It grew in 6.2% that year, in comparison to a long-term average yearly growth rate of about 5.9%. [I] To join interest rates to the money-quantity is a frequent error by those who do not realise that interest levels control not the amount of money, but its application.

The rate of US monetary growth was fairly steady at a bit less than 6 percent before the Lehman meltdown, yet interest rates (measured by the effective Fed funds rate) had varied involving 19.1% in 1981 and 1 percent in 2003. US consumer price inflation had varied between 14.4% and 1.07% to exactly the same time-scale. There is no correlation between the amount of money and these two figures in any respect, or so the management mechanisms employed, that are meant to regulate the decrease in the money’s buying power, are completely bogus.

The point was sort of approved by an official in the Bank of England a week. Richard Sharp, who is about the Bank’s fiscal stability committee, warned that if the UK Government improved its borrowing, it risked sliding to a Venezuela-style crisis. Undoubtedly, this remark was triggered by a developing debate over Jeremy Corbin’s proposal to borrow an extra #250bn if Labour is chosen. Nonetheless, it raises the question over what’s the distinction between Venezuela’s devastating inflation policies and those of Britain, besides scale. The solution is simply nothing.

Venezuela’s economic collapse to hyperinflation is our last destinations too. It is the ultimate destination for all governments that depend on funding themselves by inflation. No more are shortages being spoken about as just temporary. Realistically, the accumulation of welfare liabilities, past, future and current, also make it impossible to balance the books from taxation alone.

The fallacy that the state benefits from inflation ignores our central point: it transfers wealth from the masses. Far from stimulating the market by forcing the masses to spend instead of save, it slowly grinds them down to poverty. The elevated standards of living in the complex economies were obtained over decades by ordinary folks working to better their lives. The accumulation of personal wealth is vital for the enjoyment of improved standards of living. Eliminate wealth and earnings through currency debasement, and folks are simply poorer. And if folks are poorer, the financing of the state also become faulty.

That is why regimes that exploit the growth of money to the maximum, such as Venezuela and Zimbabwe, demonstrably impoverish their people. It requires very little intellect to work out this, yet amazingly, neo-Keynesian economists fail to grasp the point. The most appalling example was Joseph Stiglitz, a Nobel prize-winner not, who ten years ago praised the economic policies of Hugo Chavez. [Chavez] Ten years past, we know the end result of Chavez’s inflationary follies, that have taken Venezuela and her visitors to the economic abyss. Regardless of Stiglitz’s execrable mistakes, he stays an economist respected by those whose biased diagnoses are just to want reality away.