Wednesday, August 03, 2011

Are You Kidding?

Ken Rogoff is a very serious man, so I know he is NOT kidding. But what he is proposing is theft, pure and simple.

"...the real problem is that the global economy is badly overleveraged, and there is no quick escape without a scheme to transfer wealth from creditors to debtors, either through defaults, financial repression, or inflation."

So, he proposes that "we" (meaning borrowers; you creditors can go screw!) simply inflate by 4%-6% a year until we have destroyed the value of the outstanding debt.

Remember, there is a huge amount of US sovereign and corporate debt, with fixed coupon rates, in the hands of foreign banks and governments. HUGE. Foreigners "own" nearly $5 trillion in US sovereign debt. I use the scare quotes because if we do the "Full Rogoff" then it turns out they don't own what they thought they owned, after all, which was a promise to pay back the loan.

Let's do an example. Suppose inflation is 2%, the "real cost of funds" is 2% (just say, okay, for simplicity) and has been for a while.

A bond with a par value of $1,000, a coupon rate of 4% (about what US Treasuries are going for) with a maturity 20 years from now, would then be worth its par value of $1,000 (inflation 2% plus cost of funds 2% = 4% current market rate = 4% coupon rate, and again just let me simplify it this way). (A calculator, if you want to try this at home)

Now...we go to 6% inflation, not anticipated but introduced overnight and everyone knows it, it's intentional and it is not going away anytime soon. And say real cost of funds is still 2%.

What is the bond worth now?

That would be $601.49.* $400 of the bondholder's wealth has been destroyed. Well, not destroyed, exactly: stolen. Because the debtors are now paying back in inflated, less valuable dollars.

That is Rogoff's solution? Kill the rich? Abuse the idiots who loaned us money? It's impressive how soon the rule of law dies when the wealthy elites of a nation find it to be in their interest.

To be fair, Dr. Rogoff does recognize the problem: "Of course, inflation is an unfair and arbitrary transfer of income from savers to debtors. But, at the end of the day, such a transfer is the most direct approach to faster recovery. Eventually, it will take place one way or another, anyway, as Europe is painfully learning."

That's a truly remarkable statement. This action, if consciously taken by the monetary authorities, would have the effect of saying that all debtors, ALL DEBTORS regardless of size, are "too big to fail."

Wow. Remember, Dr. Rogoff is the former chief econo-shaman at the IMF. The same IMF that tells poor countries they have to pay back 100% of THEIR debts.

*Yes, that's assuming that the 2% cost of funds, 6% inflation are the new steady values. Rogoff wants 6% inflation to be temporary. But it would change expectations in a way that would make it hard to readjust very quickly. When the inflation (QE3? QE7?) ends, it would not work to say, "Okay, now we want to borrow at 4% again! We promise never to do that whole inflation thing again. That was only a one time thing."


Anonymous said...

Creditors can go screw safely now that the government requires insurance companies to give free condoms.

Anonymous said...

Let's ask WWII Germany how intentionally inflating worked out for them.

Anonymous said...

I as a lowly financial econ undergrad would beg to differ with your assessments. The creditors did take the inflation risk on themselves as tips are also for sale. It does appear just as in the 1930's we are in what has been described as a balance sheet recession. The liabilities side of the sheet did not readjust with the adjustment of the asset side. One solution would be to increase the taxes the people who actually receive most of the wealth in the society to increase the asset side of the sheet. This solution however is not palatable to one of the two parties that control policy. We are already in the process of reducing expenditures to help balance the flow situation, which will continue. You sound a bit like Mellon, "liquidate labor, liquidate stocks, liquidate farmers, liquidate real estate… it will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people." I think that it was a Minsky type cycle that allowed the cycle to occur thus the creditors must repent for their sins just as the debtors must repent. Both must be forced to absorb some losses to relearn the lessons they forgot. To Anon, something above 3% but below 6 or 7 % is hardly what pushed the Weimar Republic into the crapper. The French demanding reparations creating a liabilities overload while taking all of the asset producing regions of Germany may have had a bit more to do with them resorting to hyperinflation. I have heard all sorts of people beating the drum that the inflation boogey man is around the corner for the last 3 plus years, however it seems as far away as ever.

Anonymous #4 said...

Anon3: "We are already in the process of reducing expenditures to help balance the flow situation, which will continue."

Anon4: "Really? Kicking a small can of expenditure reductions down the road for another Congress (or perhaps even the same Congress) to undo doesn't sound like a process of reducing expenditures. I'll believe it when I see it actually happen."

James said...

So, when inflation falls below trend expectations (as it has since 2007), would you say we are stealing from debtors? Should not this theft from debtors be compensated by an equal theft from creditors?

Mungowitz said...


In fact, no, no, no, no, no.

Inflation varies, and that is why both buyers and sellers of bonds bears some risk.

This is not a variance in inflation due to external shocks. This is a conscious policy, chosen by the government, for the express purpose of repudiating the debt.

The intentionality, and the evil purpose, set this apart from the example cited by the commenters above.