authored by

John Kierans
March 2019

Inflation is good for debtors, both public and private. However inflation is bad for savers and people on fixed incomes.

This series of commentaries were first written in 2014.  I have updated and refreshed the commentaries with up to date charts etc.

The wealth transfer happens when inflation races ahead of interest rates.  There is generally a time lag before interest rates catch up with inflation.  Imagine an interest only loan being serviced at .5% for a five year period when inflation ran at 7%.   In this scenario real wealth is being transferred from the lender to the borrower at a compounding rate of 6.5% for five years - 37%.

We have seen from BIS numbers that governments have increased their debt load.   But more importantly they have shifted their debts out to longer terms and locked them in at incredibly low rates.

In a period of high inflation the real value of national debt will decrease.   Government is short of savings insofar as it has debt.  It also has large wage and pension obligations.   This short savings and earnings position causes them to favour inflation.   Likewise commercial banks and other entities with large debts and/or wage obligations  have  a  vested  interest  in  high  inflation. There gain is somebody else’s loss.

On the other side of this equation we have savers and wage earners.  In a period of high inflation savers will be locked  into  low  interest  rates  via  bank  deposits  or pension  fund  investments  in  government  debt. Obviously deflation is good for them because it increases their purchasing power. On the other hand inflation reduces the purchasing power of their money and they suffer an axiomatic loss of wealth to the net borrowers in society.   The winners in this inflation game do so at the expense of the losers.   There are no third parties, everybody is either net long of savings and earnings or net short of savings and earnings.  Ponzi schemes need losers to pay for the winners.  Savers that are invested in stock, bond and/or property market will have variable outcomes. But taken as a group they are losers.

I understand that many of the statements in the preceding   paragraph   can   be   conceived   as   a   little reductive or simplistic.  Life is a little more complicated than that.  However it can be a very useful shorthand way of summarizing today’s inflation/deflation debate.

Stable Prices = 2% inflation

Inflation  is  government  policy  and  like  all  government policy it is mostly self-serving.      Central bankers are targeting 2% annual inflation.   If you put €100,000 under your mattress and took in out in 10 years the table below shows you how much purchasing power your government will have stolen from you.   Federal Reserve chairwoman Janet Yellen thinks it is wise and humane to steal more and at a faster rate than 2%.  Central bankers don’t agree that stable prices should mean 0% inflation.

This inflation targeting discourages cash hoarding.   If you deposit your cash in a bank it can be used to increase the amount of credit/debt in the system and keep the Ponzi scheme going.    Our debt backed money system is predicated on continuous growth of credit.   Keeping people’s wealth in the bank system is conducive to this policy of continuous credit growth.   Equally it is easier to tax bank deposits.

The battle for inflation.

Central Banks are fighting hard to promote inflation.  The ECB, FED, BoE, SNB and the BoJ are to varying degrees pursuing the following inflationary polices:

  • Direct buying of government bonds
  • Direct buying of government bonds
  • Direct buying of stock markets
  • Direct  buying  of  sub  investment  level  collateral assets from banks and selected hedge funds
  • Virtually zero interest rate policy (ZIRP)
  • Forward guidance (jawboning)
  • Penalty   interest   rates   for   banks   with   excess balances (negative interest rates)
  • Scraping inconvenient ‘mark to market’ rules for insolvent banks
  • Direct  currency  printing  in  defence  of  exchange rates

The opposing forces to this inflationary push are as follows:

  • Banks deleveraging. Banks are shrinking their loan books and not extending credit as they did before
  • The private sector is not demanding more credit – applying for as many loans.
  • Increasing bank regulation is stifling bank lending.
  • Money velocity (economic activity) remains low.

My guess is that the central banks will win this battle because they are fighting for their survival and they have the political heft to stuff as much new currency into the system as they want.   Inflation often has an explosive quality.  It spends a long time coming, but when it does it really arrives with a bang.  Central banks then will try to put the genie back into the bottle by increasing interest rates. As I have already stated the lag between inflation arriving and being brought under control with higher interest rates is the ‘wealth transfer window’. Savers and bond holders are  locked  in  at  micro  interest  rates  as  inflation  snaps higher.  Borrowers and bond issuers sit back and enjoy the ride.


Although I am predicting victory for the central banks, I suspect it will be fleeting.  Considering the amount of juice that they have pumped into the system I cannot see them getting this giant genie back into the bottle.  There will be a wealth transfer window.   It will open but I suspect it will not be shut.   In other words inflation will not be brought back under control within the parameters of our existing monetary systems.

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