Raising the debt limit will likely increase inflation since most buyers of government debt, such as Federal Reserve, create new money to buy the debt. The new money lowers the value of existing money, just as an increase in any product, makes it less valuable.
For the first six months of 2011, Federal Reserve bought 85 percent of government debt. Federal Reserve usually has no reserves (never really did) and created new dollars to buy this debt. In addition, U.S. debt bought by central banks from other countries likely also came about through new units of their own nation’s money, so inflation could hit those countries as well, making the U.S. spending problem an international problem.
By inflation, I mean the monetary unit loses value. Prices won’t necessarily rise from current levels, but they will be higher than they would have been had Federal Reserve not created new dollars. Prices do not show always rise during a money devaluation because new production methods can lower production costs further than the devaluation. The dollar could lose 10 percent of its value, but if production improvements lower costs by 12 percent, prices would fall two percent, leading many to believe there is no inflation.
When it comes to inflation, prices are irrelevant, and the money quantity (known as M1) is the real information source. The money quantity has risen (or inflated) 13 percent since last July (1,722 billion to 1,947 billion), and I assume this is mostly due to purchases of U.S. debt. This means prices are or will be 13 percent higher than they would have been without these new dollars floating around.
Doomsday articles about the debt limit also complain about “rapidly rising interest rates.” If in fact they do rise, this will benefit savers. Banks now offer a measly one percent interest rates on savings accounts. The rate was more than five percent. If you have $1,000 in the bank, with a five percent interest rate, you would earn $50. With a one percent interest rate, you earn $10. The forty dollar loss goes to the person who borrowed your money.
Journalists and economists also worry about a lower credit rating for the U.S. This would be like cutting off the drunk at the bar. The U.S. doesn’t need any more debt. You can’t spend your way out of debt. And a lower credit rating might dissuade banks that enable this nightmare. A lower credit rating would require the U.S. to offer a higher interest rate to lenders, and this would the U.S. less likely to take on debt.
Creating more money for the purpose of lending to the U.S. government will harm the personal economies of individuals. People on fixed retired benefits and fixed annual salaries will have less purchasing power because their money will be devalued. Savers will continue to receive lower interest payments. And politicians will spend the U.S. into bankruptcy, turning everyone into debt serfs.
- Debt Ceiling Drama: “In fact, default happens every day through monetary policy tricks. Every time the Federal Reserve engages in more quantitative easing and devalues the dollar, it is defaulting on the American people by eroding their purchasing power and inflating their savings away.”
- What happens if the government defaults on the deficit? – “The second, a gradual informal default through inflation, is already underway. I have explained this in earlier blogs but, very briefly: The Fed has been printing money hand over fist to hold down interest rates by buying some 75% of all T-Bills it sells to finance the national deficit. It has printed more money to loan at zero percent interest to the big banks, which they immediately invest in T-Bills at a risk-free profit of 3.5%. And the Fed printed vast sums of money to enable it to buy toxic subprime mortgages which the big banks held on their balance sheets, posing a risk to their solvency.”
- The US Debt Ceiling & I – What they don’t realise and don’t admit is that the country is bankrupt.. there will be a default. The default is occurring. The people are getting less for their money and that’s how big governments and big countries default.