Saturday, May 22, 2010

Repairing Sovereign Indebtedness: Get Ready...

Sovereign indebtedness in democratic states can only really be resolved via three methods (or some combination thereof):
  1. The default route (cancellation of debts)
  2. The austerity route (drastic spending cuts and tax increases)
  3. The inflation route (“printing” money)
The Course Forward

Given that governments will not risk losing their sovereign borrowing power, the default option becomes unlikely. Moreover, given that voters will never consent to significant cuts in public programs or dramatic increases in taxes, the austerity route becomes equally unlikely. This leaves the inflation route (or “printing” money) as the most likely course forward for democratic states. Note that an important side-effect and key attraction of the inflation route for sovereign governments is to reduce the size and scale of public debt and entitlements through the inflation mechanism itself.

Best Advice

My best advice for workers is to get ready for inflation. Once the government embarks on the inflation route, unemployment will increase and remain high for the duration. Also, cost-of-living increases in pay and benefits will lag the inflation rate significantly. Even a 6-9% inflation rate over 7-10 years could mean at least a 40% reduction in real wages (and fixed pensions). Convert all existing debts (and especially mortgages) to fixed rate notes now, and eliminate all variable rate debt from your life, including credit cards. The greatest challenge for workers during periods of inflation is the risk of unexpected unemployment as firms and governments alike reduce real spending and investment under inflationary pressures. Again, get ready...

Related Posts:

How High Can Inflation Go...?

Using Inflation to Erode the US Public Debt

Implications of the Financial Crisis


Salim said...

I am surprised that there are not more bloggers thinking the same thing that you are thinking!

High schools should use this blog for teaching purposes.

JasonH said...

The rational choice is to reduce spending. However, politicians and voters are rarely rational.

Anonymous said...

Aren't we already set for inflation? That is, hasn't the gubmint *already* printed like crazy? The money is in the banks as "reserves," or elsewhere on their balance sheets. What must happen for the already completed quantitative easing to actually hit the consumer? What normal or anomalous or exogenous factors will end this interim period of disinflation or deflation and send us into inflation?

What factors and events (exclusive of demographics) will keep us out of the, what? 20 year Japanese deflation trap?


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