Is Inflation Inevitable?

This is one of those posts where I am going to put something out there and then hope that someone can explain to me where I am wrong. I am an engineer and a planner, not an economist, but I am convinced that a high (by American standards) rate of inflation is inevitable. I say this not because I have some fantastic insight or because I received some kook-email telling me to buy gold. It just seems to me that inflation is the default "answer" to a lot of our problems, especially where we are incapable of picking between one painful choice over another.

And by "answer", I don't mean to suggest it would be good. Inflation would be devastating to our cities and towns. But a good dose of inflation would fix a lot of the pressing problems we have in a way that politicians would just have to accept. I feel it is the logical result of an intractable political stalemate, which is where we seem to be.

Inflation is a term used to describe rising prices due to an excess of dollars in circulation. There are more dollars out there spread amongst the same number of goods (or in the midst of a reserve-depleting recession, fewer goods) which allows the prices of each to rise. Inflation is not the same as growth because, with inflation, it actually takes more dollars to buy the same good.

Let's look at oil for an example. Oil is traded on a world market. If it takes $100 dollars to buy a barrel of oil in 2010 and then we experience 10% inflation for the year, in 2011 that same barrel of oil would cost $110 (assuming supply and demand stay constant). It is the same oil in the same market, but the dollar is worth less and thus it takes more dollars to purchase it.

So why would inflation be good, or at least not as bad in the eyes of our political system than other, more direct and difficult choices? Let's look at debt. While the purchasing power of the dollar would decline (takes more dollars to buy the same good), people's debt would not likewise increase. In fact, inflation is one way to get rid of debt. If you owe $1,000,000 on a mortgage and then we have 10% inflation for a year, you might still owe a million, but in comparison to "the market", the real value of that debt is now $900,000. If your salary rose with the rate of inflation, you now have 10% more money to apply to your same mortgage.

So, in a country that is over-indebted at every level, wouldn't a healthy dose of inflation to reduce our debt be a good thing?

This was the logic of farmers in the early 20th Century when they supported ending the gold standard. They were all in debt to New England banks. By adopting silver, they would inflate the currency and, in relative terms, reduce their debt.

This points out the obvious opposition to inflation: banks. If you are a bank and you lent $100 million at todays value of the dollar, then we went through a prolonged inflationary period of 5 years averaging six percent inflation, the $100 million would now have the buying power of $690,000. You would have lost a tremendous amount of money, as would anyone with any significant degree of savings.

For example, what is the name of the country on the other side of the pacific.....oh yeah, China.

Let's just ponder a few of the economic imbalances that would be brought back into line with a short burst of hyperinflation or a prolonged run of modest inflation.

  1. The national debt. Thank you China for loaning us the money. Now we'll pay it back in its more worthless form.
  2. Underwater mortgages. It is not clear if inflation would increase housing prices (it did in the later 1970's/early 1980's, but right now housing is vastly overvalued as it is), but it would reduce the downward pressure and give mortgages a chance to get back in line with values.
  3. Personal indebtedness. Thank you credit card companies for loaning us money. Like China, we're now going to stiff you right back.
  4. An overly large financial sector. The financial sector has grown to over 1/3 of the economy. For a sector that should be a means to an end, not an end in and of itself, this is obscene. And counterproductive. Inflation would devastate the financial sector and put it back in line with where it likely should be.
  5. Social Security (possibly). The automatic cost of living increase for Social Security is pegged to wage increases. If wages failed to keep up with aggressive inflation, our social security liabilities would decrease.

So inflation would, in a sense, restore some fiscal discipline to a system that seems out of control. And it would be easy, too, and politically a lot less dangerous than some type of real reform. All we would need for inflation is to continue on the current course of low interest rates, increased deficit spending and the continued injection of capital into the system by the Federal Reserve. (As a side note: does anyone seriously believe any of these things will end soon anyways?)

So, if inflation fixes all of these imbalances, then why don't we just have some good old inflation? Well, because inflation is devastating. Remember those banks we all hate? Well, how much money are they going to loan if they lose money doing it? More clearly, what will the interest rate be? (Answer: extremely high.)

How about that social security recipient with a large retirement savings? How much is that savings going to be worth after a bout of inflation? (Answer: much less).

If our currency is inflating, how much is China going to be willing to loan us, and at what rate? (not much, very high) As our currency devalues, how much is that big-screen TV going to cost? (lots) Or that shirt made in China? (much more than $14.99)

You see, inflation would "fix" the imbalances by making us come to grips with how poor we actually are. It would adjust our standard of living to reflect what the current financial imbalances mask: that we can't afford to live as we are. If would force upon us, in a cruel and merciless way, the discipline we lack.

That is why the Federal Reserve always insists it is going to fight inflation. But the further we go down this path, the tougher it is going to be to hold the line. A little inflation might help a lot. But can we really control the monster once it is unleashed?

This is interesting to me in a Strong Towns context for a couple of reasons. First, our pattern of development does not generate a surplus. Individual pockets may, but in total, it costs more to service and maintain this decentralized development pattern than it generates in wealth. That is a reality we have to face, one way or the other.

We can face it as a faux-rich nation, one with the financial clout and leverage to transition to something stronger. That would be my preference. We adopt a Strong Towns approach and use our resources to transition into something that puts us on a new path to prosperity.

Or we can face it as a post-inflation nation, one with reduced financial clout and without sufficient leverage to transition. In that world, we simply abandon the weak, give up on a grand vision of America's future and do what we can to sustain as much as stagnation will allow us to.

Please, someone who knows more than me about economics, inflation, the Federal Reserve, trade imbalances, etc...explain to us all how I am wrong here. I've spent a couple of months working on this piece trying to figure out how and why inflation can be avoided. I want to be wrong, but I don't know how we address these fundamental economic imbalances without (a) leadership, or (b) inflation.

And I don't see a lot of hope right now when it comes to leadership.


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