The old joke goes “when you are in a hole stop digging.” This is not a luxury for the U.S. or Europe when it comes to piling up national debts or printing money. It isn’t an option for the world economy either.
There might be light at the end of the Covid tunnel but that twinkle of hope is still a long way away, by which time the hole in the finances of the global economy will be so large most are still unprepared to yet think about the consequences.
The bond market, which used to be considered vigilante when it came to monetary policy, is stirring to the prospect, but under the new mechanism of monetary policy will “no doubt” be bludgeoned with sacks of still wet cash back into coma again.
The bludgeon is simple and effective. The bond market wants more interest for its risk of inflation or its indigestion on too much supply, the central bank simply buys bonds from the market driving up the price and driving down the interest rate. What it buys it with might not be straight cash, but whatever it uses is heading toward cash so its little different from printing $20 bills.
That cash travels, and thank goodness because if it didn’t the financial, fiscal and monetary hole being dug by governments would not exist and we would be sat in a different smoking crater of a collapsed global economy. Global economic collapses don’t generally end well and surely no one wants landscape painters leading us in an existential fight to the death again.
So rather than a rerun of the 1930s or 1790s again, a deep pit of debt in much more palatable. Taking the U.S. as an example, it has roughly a 130% debt to GDP ratio right now. You can split hairs but it’s best to think in scale rather than points. This is heading to 150%, which might be a high estimate or perhaps a low one if things don’t go swimmingly.
At this point predicting the future comes down to setting the level where a government and economy can be comfortable with this debt load. That level was 100%; various economists suggest it can be way higher, and Japan’s is 236% (though it has mitigating circumstances insomuch as the money is not lent to it by the world, unlike the U.S., but instead is lent to it by its own meek citizens.)
So if the equilibrium point is the old 100% number, then the value of those debts must be either inflated away or real GDP grown must do the rebalance. At an optimistic 3% growth that would take too long to happen so inflation must do the job, especially as emboldened politicians will by then be addicted to handouts to the populous. Did I say handouts? Sorry, I meant stimulus.
You could be forgiven in thinking that if 150% debt to GDP was sustainable then politicians will only push that envelope harder so the outcome is set as being inflation in that instance as well.
So squishing all these variables around, it seems conservative to imagine 30% inflation in the next five years. Six percent a year…