A recent release showed inflation increased more in May than the experts predicted. The Consumer Price Index (CPI) increased 0.4% in May, surpassing the 0.2% increase anticipated by economists.
Time for a little trip back to Economics 101. Who benefits when prices go up, making a dollar less valuable? Borrowers. If I borrow $1,000 from you today and promise to pay you back $1,100 in one year, I am paying you a nominal interest rate of 10%. If inflation is 5% over that year, I am paying you back in less valuable dollars – the purchasing power of a dollar has eroded by 5% due to inflation. For example, if gas is $1.00 per gallon, one dollar buys one gallon. If gas is $1.05 per gallon, one dollar only buys 0.952 gallons of gas. That’s inflation at work. (On a side note, remember when a certain Republican president with friends in the oil industry got blamed for high gas prices? Has any complained lately about $4 a gallon gas? Hmmm.)
So, guess who’s the biggest borrower of all time? Our beloved United States Government. As of this morning, a quick look at the US National Debt Clock (http://www.usdebtclock.org/) shows the government owes approximately $17.5 TRILLION to its creditors. I did a little more snooping. According to the Treasury, we, the tax payers, are paying a blended rate of 2.427% on that debt. (http://www.treasurydirect.gov/govt/rates/pd/avg/2014/2014_05.htm ) Because these numbers are so big, I am going to show my work.
Current annual interest payments by the taxpayers, I mean US Government: $17,500,000,000,000 * 0.02427 = $424,725,000,000 ($424.7 Billion)
Let’s say interest rates go up 1%. New annual interest payment = $17,500,000,000,000 * 0.03427 = $599,725,000,000 ($599.7 Billion)
So a 1% increase in interest rates means we pay an additional $175 BILLION in interest every year. With federal tax revenues hovering around $3 trillion per year, a 1% increase in interest rates takes 5.8% away from other government programs (or to keep other spending constant, the government just adds to our debt). We can also expect higher taxes for everyone to pay for all of this, but that’s a topic for another day. Back to the inflation side. If inflation is 3% and interest rates stay at 2.427%, guess what? The purchasing power of our $17.5 trillion in debt decreases by $525 Billion. To look at it another way, the government benefits by approximately $100 Billion by borrowing in inflationary times and keeping interest rates low.
I know the real economists will destroy my analysis. Rates are fixed on most of the debt, so the increase won’t happen in a year. I also assumed the debt would stay constant. It’s not – it’s going up by the minute. The point of my analysis is keeping rates low while inflation increases helps the US out of our fiscal mess. (It also helps Japan a lot too, another country with a lot of debt and slow growth. Abenomics is based upon creating inflation.)
What does it all mean? US businesses and consumers, spooked by the Great Recession, have de-levered a lot over the last 4 years. We’re slowly taking on more debt, and we should. The government is going to help us pay that debt back with less valuable dollars. If you are on a fixed income, I am sorry. You will continue to suffer as your purchasing power gets eroded.