From: curt@ekhadafi.austin.ibm.com (Curt Finch 903 2F021 curt@aixwiz.austin.ibm.com 512-838-2806)
Newsgroups: alt.politics.clinton,tx.politics
Subject: Re: Gee, why don't we default on the US debt!!!?
Date: 5 Oct 92 21:15:20 GMT
Distribution: usa
Organization: IBM AWD, Austin

jfh@rpp386.cactus.org (John F. Haugh II) writes:
>The government can also let inflation run wild - Carter did this.  It
>has the nasty side effect that interest rates run wild as well, which
>Carter also did.  Rampant inflation (say, 15% per year) would half
>the national debt in 5 years, and put it back to pre-Reagan levels in
>10.  One nice side effect of this is that as interest rates on the
>bonds soar, the value of old bonds on the open market plummets - the
>government could move into the market and start buying up its debt for
>pennies on the dollar.

>I happen to favor the "inflation" model myself.  

I can't believe I'm hearing this from John Haugh, the save and invest
Puritan who believes in personal responsibility and less intrusive
government and all these other wonderful things.  I never thought I'd
hear John, of all people, extolling the virtues of Carter's
inflationary monetary policy.

>But to answer the questions about what would happen if we devalued
>our debt, the answer is "nothing".  We used to do it all the time.

You're serious aren't you?  You really think we can just magically
inflate our way out of the debt and noone is hurt?  All this time
and we never knew!  There really IS a free lunch!  Hurray!

Inflation has 3 very very bad consequences that I can think of
immediately.

1.  It makes it very difficult for businesses to plan what they will do
    next week or next year, or for the next decade.  This is because
    they cannot predict what their costs will be.

2.  Consumerism runs wild and noone saves anymore, because their paycheck
    will never be worth more than it is right now.

3.  It drives REAL long term interest rates UP, thereby choking the
    economy.

    REAL interest rates = interest rate - inflation +/- tax distortions

    One would think that RIR should be the same regardless of
    inflation.  I.e. if inflation is 1% and Mortgage rates are 7%, then
    18% inflation would imply 24% mortgage rates.  100% inflation would
    imply 106% etc.


Unfortunately it doesn't work that way.

Typically if inflation is low, and stays low for a long time, it is
nonvolatile.  If it is high and stays high, it is very volatile.
Theoretically if we had 25% inflation consistently for many years it
wouldn't be any worse than 1% inflation.  But whereas you can have 1%
inflation which goes to 1.5% or 2% and then back to 1% for years and
years and years, you never have 25% which moves between 25% and 26% for
years.  With high inflation comes high volatility.  It will more likely
go from 25% to 15% to 35% and keep doing this.

This pushes up real interest rates.  Lenders don't know if next week
the inflation rate will be very high or much lower.  Therefore they
demand more payoff.  Instead of lending at 31% on a 25% inflation rate
they want to lend at 45% or whatever.  This is their only protection
from volatility.

High real interest rates choke the economy.

Fear of a new round of high inflation in the US is what is keeping real
interest rates higher than they should be today.  This fear is based on
the deficit.  Deficits usually lead to high inflation eventually,
because governments have no backbone.

This same phenomenon, (inflationary volatility,) makes it difficult for
businesses to plan.  GM cannot predict what steel prices will be next
year, or labor costs or medical costs or anything else for that
matter.  As a result they have to be more conservative if they want to
stay in business, invest less, spend less, i.e. choke the economy.
Many will go out of business due to bad planning, which is bad also.

----------------------

The road to a strong economy is paved with zero inflation, zero trade
restrictions, zero taxation and zero regulation.  I.e. Free the economy
as much as possible.

Sometimes we have to make exceptions to these four rules, for the
environment, or for political reasons, (like punishing a bad country by
not trading with them, or having a welfare or public school system,)
but we have to remember when we do that we hurt the economy, destroy
wealth and make ourselves poorer.


-- 
--
curt@aixwiz.austin.ibm.com (Curt L. Finch) | AIX NFS/NIS Field Quality 
My views are unrelated to those of IBM     |        Austin, TX
 -If you vote against Bush, be fair and throw out Congressional incumbents too-
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