Debt Won’t Save You If The Inflation Hits

One of the issues that people seem to bring up to me the most is inflation, particularly hyperinflation. When people see charts like this one that show a vastly increasing money supply they are rightly concerned. One possible course of action I hear a lot is something along the lines of “hey that’s why I’m going to take out a bunch of loans so I can pay them back with cheap dollars and I’ll be protected.” Not a bad concept, and indeed it will work for a few, but based on this story about inflation in Iran (from Greg Mankiw’s blog) it’s not something I would give a very good chance of actually working if/when the time comes:

http://m.theatlantic.com/magazine/archive/2013/04/my-hyperinflation-vacation/309263

As in all cases of runaway inflation, there are winners among the losers. Iranians with foresight and the ability to borrow have profited enormously from the past year’s inflation. Many Iranians complain, Salehi-Isfahani of Virginia Tech told me later, that only the most politically connected people get significant loans from banks, so there is an inherent iniquity in the ability to profit off severe inflation. It’s easy to see why credit is rationed in Iran: the interest rate facing borrowers is fixed at 21 percent, so an inflation rate of about 30 percent means an automatic real rate of return of nearly 10 percent, just for borrowing.

This dynamic, in which savvy borrowers win big while people on fixed incomes, like the old and the retired, lose their savings, reproduces exactly what we’ve seen in previous inflation episodes elsewhere. “Hyperinflation is among the most cruel forms of government expropriation,” William Masters says. “If the government says it’s going to take your farm away, at least there’s a kind of visible honesty to that.” If you bought a large farm in Zimbabwe in 2000 and had a 30-year fixed-rate mortgage, in 2008 you could have paid that mortgage off with the 10-million-Zimbabwean-dollar note framed in Masters’s office, and expected change back in the transaction. But if you’d been in the more common situation of eking out some small savings, over many years, you’d find that your industry and foresight had been nullified, your thin cushion of savings yanked from under you.

So if you’re hoping to employ a “take out big loans to win” strategy – good luck with that. You’re likely much better off with stable money.

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