Especially Bitcoin fans are blaming fiat currencies for its inflationary nature, and with reason. Bitcoin has a limited supply, the number of BTC which can be created can’t exceed 21 millions. But Bitcoin inflation this year is still higher than the inflation of many fiat currencies. (See here.) Now I’d like to tell you some stories of the nature of fiat inflation and its relation with debt crisis.

Debt after debt

Many people are afraid of a new economic or financial crisis and with a reason. After the crash of 2008-2009, the debt in many countries was treated with even more debt, as if policy-makers had been learned nothing from the past. In some countries banks had to be rescued from the trouble, in others mortgage borrowers were saved, avoiding the loss of their homes. All this mostly issuing new bonds, making new debt.

We have more and more people getting auto-loans (that they can’t afford) for cars, mortgages (that they can’t afford) for housing, regular loans (that they can’t afford) to pay off school-debts, school debt itself is at an all time high. I just feel like we have about 3-4 debt bubbles all growing at once. My theory is that when you have multiple bubbles growing at the same time, the “popping” effect will be ten-times greater than with single debt-bubbles

• wrote for example @stuffbyspencer in a comment. And many other people feel something similar.

Three ways to handle debt

Means this that a new, even bigger crisis is inevitable? I think, not. There are basically three ways to handle debt:

1. Pay it off, pay it back. It can be very difficult. In case of states, even your grandchildren can suffer from it. But with a surging economic growth, general prosperity, higher incomes it can be much easier. Unfortunately many countries aren’t really growing in last years.
2. Refuse the payment (declare bankruptcy, default). It can have tough consequences, for example, creditors won’t trust you again for many years. Although some countries like Argentina or Greece are making wonders and only some years after a default, are receiving new loans again.
3. States can inflate it. Inflate the debt which they have taken means paying lower interests than the inflation. (Negative real interest rate.) If inflation is 4 percent and you pay 2 percent interest (yield) for the bonds issued, the debt loses two percent of its value each year. (Compound interest can help you, too.)

In special cases, in extreme circumstances a high inflation will make debt quickly worthless. Let’s say, a hyper-inflation. For example 30 percent of inflation and 20 percent of interests. But this is happening mostly in dictatorships and soft-dictatorships. In democracies this is rare, high inflation mostly happens in war times or heavy economic crashes.

The debt was higher before

Inflation is taxation without legislation. Milton Friedman

This chart of Wikipedia is very interesting. “Federal debt held by the public as a percentage of gross domestic product, from 1790 to 2013, projected to 2038.” As you can see after the World War 2, the US federal debt was very high, but they managed to lower it. How?

Another Wikipedia-article explains it:

In the late 1940s through the early 1970s, the US and UK both reduced their debt burden by about 30% to 40% of GDP per decade by taking advantage of negative real interest rates

And now, we have it again

Besides, the economic growth was also very high in the post-war decades. In fact, they applied nr. 1. and nr. 3. of my list above, parallel.

By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens.
John Maynard Keynes

Another Wikipedia-quote can explain you some details from the present:

Negative real interest rates are an important factor in government fiscal policy. Since 2010, the U.S. Treasury has been obtaining negative real interest rates on government debt, meaning the inflation rate is greater than the interest rate paid on the debt.

Yes, they are inflating the money, again. Many bond yields and interests of bank savings are below the costumer price inflation. In the Eurozone, too. We have here approximately 1.5 of y/y inflation and 1-2 year bond yields are between 0-1 percent in the most secure countries like Germany or France. So bond holders are paying the bill of the debt, losing all the time in real terms. But also citizens holding bank accounts, small investors are paying the bill.

There are worse countries

I’m sure many politicians, central bank leaders are glad actually if they can generate inflation in these years. And push bond yields lower at the same time. But they will never admit it. Perhaps they are right, because inflating the money is a much more pacific way to solve the crisis than declare bankruptcy, or initiate other, new austerity measures.

You can hate the USA or the European Union, but citizens of developing countries often are in worse situations. If you live in a country where inflation isn’t calculated anymore, better escape from there. That was the case in Argentina some years ago, or in Venezuela now. In both cases a heavy crisis followed the stalling of the calculations. It’s a basic statistical indicator: without inflation we have no true picture of the economy.

(Cover photo: Pixabay.com)