The economics discussion would have a great deal more clarity if it were broadly understood that underlying all lending and borrowing is the movement of actual goods and services. Lenders are forfeiting near-term access to goods and services to borrowers who need near-term access, but only based on the expectation of access to goods and services in greater amounts (the interest rate for money loaned) at a later date.
This truth came to mind while reading a recent co-authored opinion piece by the Hoover Institution’s John Cochrane and Stanford Ph.D candidate Jon Hartley. They write that “debt and deficits do not automatically cause inflation,” which is of course true. Truer would be for them to write that debt and deficits have nothing to do with inflation. Inflation is currency devaluation, which is a policy choice.
Government spending is a policy choice too, but it logically has nothing to do with prices which are at best a consequence of inflation as is. Still, government spending can’t realistically alter prices because underlying all the spending is the shifting of money from one set of pockets to another set. Government consumption doesn’t represent new demand simply because government produces nothing. Which means spending by government or by those favored by government by definition signals reduced spending by the taxed individuals who produced the wealth in the first place.
Deficits also don’t cause the policy choice that is devaluation, plus they logically occur absent devaluation in consideration of what’s true about lending: once again, no one lends money as much as they shift near-term access to goods and services to those who need it in return for greater access (the rate of interest) to goods and services at a later date. In other words, if deficits caused inflation, there would logically be no deficits. Really, who would forfeit consumption now in return for dollar returns in the future that would be exchangeable for fewer goods and services?
Cochrane and Hartley would seemingly agree with all of the above, or at least agree that “debt and deficits do not automatically cause inflation,” which was why it wasn't anticipated that they would assert that deficits do cause inflation if the borrowing government lacks “a believable plan for repayment.” If so, they write that “People try to get rid of public debt, pushing up prices until its real value is back to what people think government will repay.” That's one way of looking at it, but a case will be made that there's a more positive way of looking at the issue.
Figure that if Canada lacked “a believable plan for repayment” of its borrowings then it seems there wouldn’t have been a market for such a sizable chunk of debt. This isn’t to say that investors don’t err on occasion, but investors certainly don't set out to fund governments that lack the means to repay what they've borrowed.
From there, we get back to the truth about debt whereby it’s yet again a shift of near-term resource access to the borrower in return for greater resource access for the lender in time. Which is a long or short way of saying that while there might be dumb money out there, rare are the investors that would purposely purchase debt in order to take a haircut. Did they simply buy debt unaware of its junky quality? That's unlikely, as it unlikely that Cochrane and Hartley would know what skin-in-the-game investors apparently did not know.
Which brings us back to the contention that country debt incurred is inflationary if when there’s no “believable plan for repayment.” Except that if there’s no “believable plan for repayment,” then there’s logically no debt. Figure that markets by virtue of being markets are going to sniff out what’s not credible first, only for borrowing windows to close.
About what’s been written, none of it should be construed as an assertion that governments never default, or devalue (inflation) their way out of debt. Of course they do. But the default is a policy choice, as is the devaluation a policy choice. If it were an automatic consequence of governments borrowing too much, then the borrowing wouldn’t happen to begin with.
Markets for debt are wise, precisely because the compound interest costs of poor lending decisions are immense. The mere assumption that government borrowing somehow causes inflation presumes a level of information asymmetry that doesn’t exist in very deep country debt markets, and that arguably never has existed.
