Inflation Saves the Day?

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http://economictimes.indiatimes.com/opinion/columnists/swaminathan-s-a-aiyar/inflation-is-the-most-likely-way-out-of-rising-oecd-debt-problem/articleshow/9463742.cms?utm_source=twitterfeed&utm_medium=twitter

Inflation is the most likely way out of rising OECD debt problem

The world economy is reeling under the burden of rising government debt in OECD countries. I predict that the main way out will eventually be inflation. Huge monetary stimuli in many countries have already created the potential for inflation. And, given the political difficulties politicians face in either raising taxes or cutting spending, the most likely way to tame rising debt/GDP ratios seems to be inflation.

Inflation erodes the real value of outstanding debt. It is a tax by another name that helps governments balance budgets. It is unpopular, but right now spending cuts and tax increases look even more unpopular. In cases of political gridlock, inflation can be an unwitting solution because it can happen without explicit government action.

Doubts are growing about the debt sustainability of ever more economies in Europe. Rising interest rates for gilts in Spain and Italy now threaten their long-term fiscal sustainability. Germany is soaring, but cannot compensate for all European laggards. Greece, Portugal and Ireland are small peripheral economies. But Spain is a large economy and Italy is a G-7 member, no less. Any default by Spain or Italy will cause a huge financial crisis.

Despite monetary and fiscal stimuli since 2007, the US economy is still struggling. GDP growth was just 0.4% and 1.3% respectively in the first two quarters of 2011. So, revenues are sluggish and the fiscal deficit remains high. The US debt/GDP ratio looks certain to cross 100% soon. Economists Reinhart and Rogoff have shown that recovery from a recession caused by a financial crisis can be very slow.

Neither massive stimuli (as in the US) nor austerity budgets (as in the UK, Greece, Portugal, Ireland and Spain) look like producing much-needed growth. Without growth, the debt/GDP ratios of these countries will keep worsening.

The limits of Keynesian economics have been exposed cruelly. Big stimuli can get you out of a recession, but cannot guarantee that growth will be fast enough to automatically tame burgeoning debt. Keynes formulated his theories in the context of a closed economy. But today OECD economies are open, so fiscal and monetary stimuli can leak out.

If you stimulate consumer spending through tax cuts, you may simply stimulate imports rather than domestic production. A monetary stimulus may mean that cheap money is used to invest in other countries, not your own. This partly explains why huge stimuli in OECD countries have fuelled growth in emerging markets and commodity producers rather than in the OECD.

Inflation will enable the OECD to strike back. It will erode the real value of huge foreign exchange reserves - and private holdings of OECD gilts and corporate bonds - held by developing countries, and thus amount to a massive write-down of OECD debt. Developing countries will want to diversify out of OECD gilts, but there are no comparable alternatives. A partial hedge is available in gold or other commodities, whose prices have therefore been rising. This commodity boom may seem paradoxical at a time when global growth prospects are worsening, but it reflects inflation fears. 

[JeffreyS]

Very interesting indeed.  So if I raise the prices to my customers I am being a good patriot.  I don't know how well they are going to take it but I am willing to try.