By John Tamny for RealClearMarkets
In 1815, Great Britain could claim government debt that was 261% of GDP. Did inflation ensue? No. The pound was tied to gold.
In 1945, war spending had U.S. federal debt well north of 100%. Did the dollar subsequently collapse? No. The dollar was defined as 1/35th of a gold ounce.
Too much gold for you? That’s fine. Let’s move to Asia. Japan in particular. Its government debt has soared over the decades. During that time the yen has risen pretty substantially against the dollar from 360/1USD to 114/1USD.
And what about the U.S.? In 1980, total U.S. federal debt was a little bit above $900 billion. At the time, the yield on the 10-year Treasury note was over 11%. Fast forward to 2022, and total federal debt has zoomed upward to $30 trillion. The yield on the 10-year is 1.71%. If readers are confused, Treasuries pay dollar income streams. In other words, if all the debt amassed over the decades by the U.S. had resulted in inflation, Treasury yields would have risen, not fallen.
The above stats are just a few data points to call into the question the increasingly popular narrative among economists, pundits, and very deep thinkers about the alleged relationship between government debt and inflation. There is none.
To be clear about what was just said, this opinion piece is not a defense of government spending or borrowing. Government spending is a freedom and economy-sapping tax, period. When governments spend either thanks to taxation or borrowing, the economy-neutering effect is the same. And it’s harmful. If you believe otherwise, and most economists puzzlingly do, you believe Nancy Pelosi and Mitch McConnell are better capital allocators than Jeff Bezos and Peter Thiel.
The main thing is that statistics or history aren’t necessary to show why government debt doesn’t cause inflation. Logic is all that’s required. Inflation is a devaluation of the currency. Yet budget deficits signal a willingness on the part of investors to buy future income streams from the government taking on the debt.
Ok, so by the thought processes of the pundit and economics classes, investors eagerly fund the borrowing of the very nations that intend to stiff them with devaluation. No, it doesn’t work that way. Or it doesn’t have to.
Indeed, it’s no doubt true that more than a few nations have devalued their way out of massive debt over the decades and centuries. But it’s a reminder that debt doesn’t cause inflation, as much as some nations choose to foist their profligacy on their citizens and creditors. Which means the pundit class is reversing causation.
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While nations that do a reasonable job of protecting their currencies can run up lots of debt, nations that inflate it away cannot. All of which is a long or short way of saying that inflation restrains government borrowing. Which is a statement of the obvious.
Many in the pundit class will say “central banks” conduct just that sort of lending. Oh dear….So we’re supposed to believe that arms of government can finance government? If this were even remotely true, the Soviet Union would still exist today care of Gosbank.
Despite the tendency of the deep in thought to get deficits and inflation backwards, they keep making their silly cases. In an opinion piece last week for the Wall Street Journal, Thomas Sargent and William Silber cited Milton Friedman’s quip in the 1970s that inflation had resulted from “ever more goodies” sans commensurate tax hikes as the cause of the 1970s inflation.
Oh yes, nothing to do with the explicit devaluation of the dollar in 1971 whereby President Nixon severed the dollar’s link to gold. Naaah. Nothing to see there.
Except that there’s no basis for this. The governments that want deep markets for their debt don’t make a point of routinely devaluing, while those that don’t care as much about borrowing do. Which brings us to another prominent economist who recently made a case for government debt as the instigator of inflation in an interview. The economist described it this way:
“The U.S. government has $20 trillion of debt outstanding. That means, over the long run, people must expect taxes to exceed spending by $20 trillion to repay the debt. But if they think the government will be able to pay back only $10 trillion in today’s money, people will try to get rid of their government debt fast. They’ll try to sell it to buy other things, driving up the price of everything else.”
Oh well, books could be written about all the falsehoods within a short paragraph. But with brevity it mind it should be said that in addition to mistaking rising prices for the currency devaluation that is inflation (there’s a difference), the economist was wholly contradictory in his analysis.
For one, assuming debt holders are selling Treasuries in order to “buy other things,” by definition someone else is not “buying other things” in order to purchase the debt. There’s no increase in “demand.” And even if there were, that wouldn’t be inflation.
For two, if there’s an obvious correlation between debt and inflation as he assumes, markets don’t wait for the known. The economist implies that eventually debt owners will be able to sell debt worth $20 trillion that is really only worth $10 trillion. In what market and on what planet does this work whereby the buyer has none of the information the seller possesses?
For three, there’s no obvious correlation between debt or debt/GDP and inflation. See above. The economist once again presumes that buyers of debt don’t know what sellers know, and high IQ academics like him know.
The economist’s analysis implies that markets aren’t just stupid, but dense on a staggering level. Same with the analysis of Sargent and Silber. Back to reality, government spending is an economy-sapping tax, while the currency devaluation that is inflation is a policy choice.
Some governments choose socialism to lay off their debt. But they don’t have to. Economists presume the silliest things….
Syndicated with permission from Real Clear Wire.
John Tamny is editor of RealClearMarkets, Vice President at FreedomWorks, a senior fellow at the Market Institute, and a senior economic adviser to Applied Finance Advisors (www.appliedfinance.com). His most recent book is When Politicians Panicked: The New Coronavirus, Expert Opinion, and a Tragic Lapse of Reason.
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