Debt, Inflation, & Money Printing

Alex Gallagher
Mar 14 · 10 min read

A Simpleton’s attempt at providing some marcoencomic perspective.

Introduction

In the emergence of the post-war economy, North America experienced a period of tremendous growth from post-war industrialization. Productivity was booming as manufacturing technology used in wartime manufacturing found its way into factories of all sorts, enabling production of commercial goods at scale. With this booming industrialization, employment shot up, wages went up, the middle class grew, people had disposable income to buy these commercial goods, and a cyclical model of growth materialized.

Arguably, we have never before experienced a time when such a large portion of society were at the prime working age, the public had a demand for goods, and most importantly, a strong middle class made up a large contribution of the nation’s purchasing power. This post-war era was driven by growth — technology invented new products (televisions, microwaves, vacuum cleaners, etc.), America had the jobs to produce those products, and consequently, the money to purchase them.

Over time, this generation, the Baby Boomer generation, eventually reached maximum economic productivity. The peak number of Boomers were in the workforce, purchasing more goods than they ever would, and then growth subsided. The subsequent generation X-er’s, were a smaller generation by population, and less aggregate demand for goods ensued. Couple this with more efficient manufacturing technology replacing factory workers at the margins slowly, and then very quickly, and economic growth was bound to experience relative slow-downs from the peak Boomer era.

Debt

Until credit cards were invented, consumer debt was very much out of the ordinary — people only ever paid for things in full and their mortgage would have largely been the only debt they would have been familiar with. With the advent of credit cards, marketing practices popularized the idea of buying things now and paying for them later. People starting financing things like higher-priced department store items, home renovations, cars, vacations, etc. This new consumer debt helped bridge the void left by the demand for goods during the peak-Boomer era. Queue the transition from the growth-driven economy to the debt-driven economy.

Why do People Take out Debt?

Generally, people take out debt in order to forgo paying for something now, perhaps when they don’t have the money, to pay for it later. This can make sense, especially for large and productive purposes, and isn’t always a bad practice.

How can Debt be Good?

Generally, debt is good if it is productive debt. Productive debt usually pays for something that will increase your ability to produce future cashflows — think of a real estate rental, a productive education, or a small business. On the flip side of that, unproductive debt would be put towards things that are liabilities — think vacations, cars, or other consumer items. Unproductive debt generally does more harm, rather than good, when it comes to your ability to repay your initial loan.

Over time, it has become increasingly acceptable to take on debt for any number of things. In this debt-driven economy it is commonplace to carry a credit card balance and for one to have loans taken out for education, cars, or both.

I think the education system has failed the average citizen, thus largely making the rate of interest irrelevant for most consumers — marketing has hyper-focused the public on only paying attention to the size of your monthly payment, while minimizing the importance of the length of the term, thus obfuscating the total amount that good is going to end up costing you. Ex) $12 000 used car on a 60-month payment plan at 5.5% will cost you more than $13 500, though the dealership will focus on the $200 monthly payments. Society has told us that you can have your cake and eat it too. Take out the debt, at whatever cost, so you can have what you want today.

Inflation

What is Inflation?

Inflation is how the price of a good increases over time. Deflation would be how the price of a good decreases over time. It is important to think of the equation of inflation as a two-sided coin — sometimes it is not the fact that the item you want is costing more, but that your money is actually worth less, so you need more of it to buy the same number of things. As a result, inflation is a direct correlation with your currency’s purchasing power.

IMPORTANT NOTE: The rate of inflation is not consistent amongst all goods. Different items experience different rates of inflation. Technology is deflationary, bringing the costs of digital services down overtime (think the cost of video, music, photos, etc.). Scarce commodities will always be subject to higher inflation — you have a theoretical limitless number of dollars all chasing a fixed supply (think land/real estate or rare earth metals).

The inflation we hear about in the news, measured by the Consumer Price Index (CPI), is the average price of an ever-fluctuating basket of goods used as an index to measure the rising costs of goods overtime. This basket includes everyday items such as the average price for a burger, lightbulbs, clothing, cars, etc.

Is Inflation Good or Bad?

Inflation is not inherently a good or a bad thing, we attach a connotation to inflation based on our own personal financial situation. Inflation for a labourer can be devastating, as more money is drained from their 9–5 paycheck to pay for the rising cost of necessities like food and shelter. Inflation is viewed much differently for an investor, who benefits from inflation through the increase of their asset prices (real estate, stocks, gold, etc.).

Illustrating the impacts of inflation on loans and asset prices, look to real estate for an easily digestible example:

Today, the $250 000 mortgage you took out 25 years ago would be like $140 000 today, but the house would have appreciated, because of inflation, to a value of around $415 000 (using an average rate of inflation of 1.76%).

Why do Government’s Want inflation?

Whether true or not, I’ve always had the perception that inflation is used as the driver to keep people working. If we lived in a deflationary world, the money you have today would be worth more tomorrow, incentivizing you to save your money so you can buy more the next day. It’s important to remember that when you spend your money, you’re helping to pay for the salary of the employees involved in providing that product for you — think of buying a loaf of bread from a bakery (you’re contributing to the salaries of the employees of the store, the truckers who delivered the ingredients, the farmers who grew the grain, etc.). The government wants high employment and thus needs people to be spending money in the economy. A deflationary environment would prevent people from spending, while an inflationary environment would encourage people to spend today to get the most for their money.

Another important consideration, perhaps the most important, for why governments may want inflation is the impacts inflation has on debt. Generally, we think of debt and inflation as bad, though when we have debt, we should favour inflationary environments. Remember that inflation is effectively how much your money is worth. If over time your money is worth less and less, inflation is high, your effective debt goes down in real terms. The flip side of this, and what governments all over the world fear, is that in deflationary environments your debt is more expensive. Governments own A LOT of debt and a deflationary environment would render it close to impossible to payback their debts.

What Contributes to Government Debt?

Municipalities cannot run a deficit, but provinces, and more importantly the country, can. Taxes make up the bulk of the country’s operating income and is used to fund services such as public education, healthcare, infrastructure projects, and social security. When the country needs to borrow money the Bank of Canada acts a lender that can give them effectively a blank-cheque loan. Countries will take out large deficit loans in times of great need — large infrastructure projects, war (pay for supplies, training, equipment, etc.), or other crises (like a pandemic perhaps — paying for things like CERB).

What Choices does the Government have to Repay their Debt?

It is important to remember that government income effectively comes from taxpayers. Governments could eventually repay their debts from taxpayer money alone if given enough time AND, more importantly, if they paused all borrowing until all loans have been repaid. This scenario is very unrealistic as the needs of the people always tend to trend higher, not lower.

Another important idea to consider is the fact that if the public is indebted too much, a financial burden is placed on the taxpayer and they will be pressured to spend less (maybe downsize their home) so they can hope to pay back their loans. This in turn making less money available for tax, and consequently, the government.

With over indebted governments and public citizens alike, it is very difficult to pay off large amounts of debt in real terms. The government has three options:

1) AUSTERITY: The government could raise interest rates, making it more expensive to borrow and making it increasingly profitable to save. Additionally, another popular tactic when needing to trim the federal budget is to cut funding for social security, healthcare, education, etc. This action would raise unemployment and leave many people dependent on the state for services struggling for basic survival.

2) DEFAULT: The government could default on their loans. This would lower confidence in the nation and drive away future investments in the country. Government debt is monetized as bonds that investors can purchase and is seen as a risk-free investment since reputable governments always payout these investments. Traditionally, pension and retirement funds are made up of 40% fixed income investments and bonds would contribute to a large portion of this 40%. Defaulting on these government bonds would give the holder $0 return on their initial purchase, contributing to irreversible losses for many retirees (future and present).

3) INFLATION: Remembering that inflation is effectively a correlation of how much your money is worth, and in turn your debt, one option is to make your money worth less to minimize your debt in real terms. This is the most politically popular route to take when faced with extremely large deficits — no one must experience tough times, everyone gets their healthcare, social security services, bond investors are happy, etc. In an ideal world, an injection of money is added to the current supply, making every dollar worth less, wages continue to increase, and eventually proportional debt levels are more easily paid off. That loaf of bread now costs $4.00, but you got a raise so it’s okay.

Where Can we see Inflation Today?

In an ideal world, inflation is kept positive, but at a small (almost unnoticeable) rate. However, we have reached a point of unprecedented money-printing — 50% more money was printed to fight COVID-19 in America compared to what was printed to fund WWII. In 2020, 1 in 5 dollars that existed was printed within the last year. I write this as the American president has just signed off on an additional 1.9 trillion-dollar relief bill while talking about what funding is coming next. As you can see, we have entered an era of unprecedented money-printing, where inflation can already be seen if you know where to look.

As every central bank around the world is printing money, we can see the onset of inflation occur in a select number of assets. New money is printed, enters the system, and those who need it will use it for essentials like rent and food. You can already see noticeable increases in food prices today compared to a year ago. Alternatively, those who do not need this extra money will look to park their cash somewhere where it will not become worth less over time due to inflation — two very popular investments where you can see the impacts of asset inflation are housing and the stock market. It would be difficult for someone to have lived the last year and NOT have heard about the extraordinary increases in housing prices and massive speculation in the stock market. People may purchase either of these two investments for a myriad of reasons, but I do not believe that we can overlook additional money supply as a factor pushing these asset prices up.

An important thing to consider moving on from this COVID-19 pandemic is what happens when things open again and those who have accumulated savings during the lockdown start spending that money in the economy. As the velocity of money increases (the rate at which money changes hands), money that was parked in savings accounts is effectively added to the functional money supply — an increase in customers will be looking to buy products that are available. Basic economics will tell us that an increased demand for goods, chasing a finite supply will push the price of those goods higher — it is very likely that post-pandemic, inflation will become even more prevalent, in more facets of life, as increased spending occurs.

To be on the favourable side of inflation, you will want to own things that will benefit from an inflationary environment (like investments). The investments that will most benefit from an inflationary supply will be scare goods. Scarce goods can, like a sponge, soak up additional monetary supply. This is how one may predict a continued boom in real estate, fine art, and precious metal markets.

Conclusion

It is my belief, that because governments have over-leveraged themselves with debt, their only choice is to print money, causing inflation. Assets with a fixed supply will continue to thrive in this environment as increased money chases the same number of goods. It is my belief as well, that this theory helps to explain why Bitcoin has seen massive growth (more than 10x returns) since a year ago today.

Further Writing:

  • The Search for Yield as Interest Rates Approach Zero/Negative
  • The ‘Ponzi Scheme’ of Bitcoin vs The Fiat Ponzi Scheme
  • A Transition to a Post-Fiat World
  • Central Bank Digital Currencies

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