Thursday, August 6, 2009
UBS economist Paul Donovan shows that governments can't inflate their way out of debt traps:
Inflation pessimists cling resolutely to the belief that inflation will inevitably return. “Fiscal deficits are rising dramatically” goes the argument. “Governments will have to create inflation to reduce debt: GDP ratios, as they have done in the past.”So if inflation isn't the ticket out of the debt trap, what is?
The problem with the idea of governments inflating their way out of a debt burden is that it does not work. Absent episodes of hyper-inflation, it is a strategy that has never worked. Government debt: GDP burdens tend to be positively correlated with inflation. Market mythology has created the idea that inflation will help reduce government debt ratios. The facts do not support the myth. [G]overnment debt rises as inflation rises. Meaningful reductions in government debt will require a low inflation future...
The higher debt service cost becomes a problem for a government that is pursuing an inflation strategy because government debt does have to be rolled over. Unless a government is willing to pursue hyper-inflation as a strategy, raising inflation will not reduce the government debt burden. Indeed, history indicates that the reverse result will be achieved.
According to Ellen Brown, even countries which are so deep in debt that they are bankrupt have regained prosperity by taking over the money and credit creation functions from private banks. See this and this.
Abolishing the Fed and the other private central banks and reclaiming the sovereign power to create money may be the only way out of the debt trap.