Can monetary inflation reduce the federal debt?

From "Government's Diminishing Benefits from Inflation" by Jeffrey Rogers Hummel.

"If inflation is totally unanticipated or unexpectedly high, interest rates will not have risen enough to compensate for the decline in the purchasing power of any loans. Net debtors gain, and net creditors lose. Government is, of course, the economy's biggest debtor. Unanticipated inflation therefore reduces the real value of government debt."

"During the Great Inflation of the 1970s private investors holding long-term U.S. Treasury securities actually earned negative real returns despite receiving positive nominal interest. As a consequence, from 1946 to 1982, while the nominal debt that the U.S. government owed to the general public rose from $242 billion to $925 billion, that debt in 1946 dollars had actually fallen to $201 billion."

Understand the jargon . . .

NOMINAL is a fancy word for NAME. Economists like to use this word, nominal, because, even though you may name something a dollar, not all dollars are necessarily worth the same amount. They may have the same name, or deNOMination, but NOT the same value. For instance . . .

If there are 1 trillion dollars in circulation in 2007, but the Federal Reserve creates an additional 1 trillion dollars in 2008, all of the 2008 dollars will be nominally the same as the 2007 dollars, because they will all have the same name, but the REAL VALUE of dollars in 2008 will be substantially less than dollars in 2007.

Thus . . .

A $100 loan at 10% interest made in 2007 dollars will nominally return $110, but the REAL RETURN will be less than that because the Federal Reserve has inflated the money supply.

Focus on what happened in the example Professor Hummel discusses . . .

  • Those who loaned money to the Federal State tried to compensate themselves for the changing value of the dollar by charging higher interest rates.
  • The monetary inflation happened faster than expected, so the higher interest rates weren't enough to compensate.
  • NOMINAL federal debt rose from $242 billion to $925 billion between 1946 and 1982, but . . .
  • Monetary inflation caused the REAL VALUE of that debt to fall to $201 billion (as expressed in terms of 1946 dollars)
  • This means that monetary inflation by the Federal Reserve caused those who loaned money to the Federal State to lose billions of dollars!

Try to remember these numbers for use in conversation . . .

  • Nominal Federal debt rose from $242 billion in 1946, to $925 billion in 1982
  • Monetary inflation -- legalized counterfeiting -- caused the real value of this debt, as measured in 1946 dollars, to fall to $201 billion.