Pragmatic Capitalism

Capital for Living a More Practical Life

Inflation is NOT Necessarily a “Different Form of Default”

Warning – this is likely to be an extremely unpopular post with a lot of people.  I apologize in advance for any inconvenience this causes your political biases.  I also apologize for the snarkiness in this warning.    

Every time I point out that the US government is a contingent currency issuer that can’t “run out of money” the same inevitable response always pops up where someone says that insolvency is really no different than what inflation is because inflation is just a “different type of default”.  This can be very misleading.  Let me explain.

We reside in a credit based monetary system.  That means almost all of the money in our system exists as a result of a simple accounting relationship.  Let’s say you have a great idea for a new technology that you think everyone will love and you think this technology will improve living standards.  But you don’t have the funding to produce and market the new technology so you go to your local bank to take on a loan.  You have excellent credit and maybe even some collateral so the bank is happy to extend you some credit.  In doing so the bank creates a loan which creates a deposit for you to go out and spend.

What’s happened here?  The money supply has increased.  And so has your purchasing power.  And you use that purchasing power to go out and build your new technology and sell it.  Let’s assume that after a few years of this your technology is a big success, has made many lives better, improved productivity for others and increased the amount of other goods and services your labor hours can currently purchase.  In other words, society is better off because of your technology despite the increase in the money supply and the inevitable inflation that will likely accompany this.

The key is understanding the simple point that enhancements in productivity allow us to consume and produce more goods and service with the same number of labor hours!   Said differently, your living standard improves despite an increase in inflation.

The US economy over the last 100+ years is basically one big example of this relationship between credit, inflation and output.  Here are some long-term charts displaying what was essentially described above:




In a credit based monetary system credit IS money.  And the supply of credit will expand over time as the economy grows to support a larger credit base.  Yes, at times this system will inevitably become unstable because its participants will take on more credit than they can afford or make other irrational decisions that cause imbalances, but over the long-term the economy is basically one big credit creating productivity enhancing machine that pretty much ALWAYS has higher inflation, higher credit levels AND, most importantly, increased productivity and output.  So no, it’s not right to say that higher inflation is a “different form of default”.  Despite the decline in the purchasing power of the dollar over the last 100+ years we are all actually better off because our productivity allows us to purchase more goods and services with the same number of labor hours.  Inflation and insolvency are totally different animals with very different causes.  If we want to understand these things and how they impact our lives then we need to better understand the causes here.

So, next time someone says that inflation is just a different form of default tell them to explore the details a bit more.  They might be right in some cases (like the very rare hyperinflation), but odds are they’re misleading….

And please, read the following pieces before responding about hyperinflation or how the government’s inflation statistics are all lies (since those are the next inevitable retorts to a post like this):

What do the independent inflation gauges say?

Understanding the causes of hyperinflation

Can a Sovereign Currency Issuer Default?


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