A conversation about inflation

[Exsubmariner]

So I was recently sitting and speaking for a few hours about economics with one of my friends and childhood teachers. The case of a mortgage came up and he went off explaining about how, because of inflation, holding a mortgage was beneficial to the borrower.

You see, when the borrower first gets the loan, it may be a $1200 a month payment. Now, this is a fixed rate, 30 year loan in our example. Let us say that the borrower brings home, after taxes, $3000 a month. Now assuming a rate of 4% of inflation, and assuming that the borrowers pay rate stays constant in the face of inflation, than that means that in 15 years, the borrowers take home pay will have increased by a factor of 1.8 (using the compound interest formula) to $5402 a month. All the while, the mortgage payment remains constant at $1200. What's more, the owner can take the extra $, which are inflated from the original value of the loan amount and pay them into prinicple, thereby paying off the loan sooner.

There are a lot of other factors to consider. However, I think that a very strong case can be made that inflation benefits the borrower, i.e. the consumer. The opponents of the FED will constantly talk about inflation being a "tax," but overlook the fact that it actually is a tax in favor of a borrower, who is spending money. They often say that the tax is against the lender and investor.

Does the investor represent a market or does the consumer represent a market? In a market, does the investor create the market or does the consumer? How would a market function that constantly concentrated money in the hands of investors and not consumers? I think there would be a shortage of consumers.

There seems to be a contradiction in the logic against arguments railing against an inflationary monetary policy. Something that I often hear in conjunction with such arguements is that it is a bad thing to concentrate wealth into the hands of a minority. No inflation, they say, is essential for keeping the value of money in the hands of the many. It seems, however, that the effects of inflation being of benefit to the borrower in fact serve to prevent the accumulation of capital to the hands of the few, creating more consumers and therefore more market.

[MrMon]

I'm sure the usual gang will chime in, but you're basically correct. Hard money/no inflation is great if you have money, it sucks if you don't, as credit markets pretty much dry up. Ours is a credit based economy.

The arguments went on all during the late 19th century, as I've pointed out in other threads, and were pretty much decided in favor of the soft money faction. The hard money faction does have a point, the value of money does decline over time, but the consequences of hard money are pretty harsh as well, and the world has decided that the downside of soft money is the lesser evil.

[bobman0330]

Any fixed-rate mortgage loan includes an amount sufficient to compensate for predicted inflation. Only to the extent that actual inflation exceeds what was expected is there a transfer to the borrower (and vice versa if inflation is less than expected.)

It is the case though that a sudden shift to a gold standard or similar inflation-free currency would be a pretty serious blow to anyone owing fixed-rate debt.

[MrMon]

[ QUOTE ]
Any fixed-rate mortgage loan includes an amount sufficient to compensate for predicted inflation. Only to the extent that actual inflation exceeds what was expected is there a transfer to the borrower (and vice versa if inflation is less than expected.)

It is the case though that a sudden shift to a gold standard or similar inflation-free currency would be a pretty serious blow to anyone owing fixed-rate debt.

[/ QUOTE ]

That's assuming they couldn't refinance of course. Most home mortgages (the majority of consumer debt) do not contain prepayment penalty clauses, so if it happened, which is highly unlikely, people would freely refinance, just as they did when interest rates dropped from 2000-05.

[bobman0330]

[ QUOTE ]
[ QUOTE ]
Any fixed-rate mortgage loan includes an amount sufficient to compensate for predicted inflation. Only to the extent that actual inflation exceeds what was expected is there a transfer to the borrower (and vice versa if inflation is less than expected.)

It is the case though that a sudden shift to a gold standard or similar inflation-free currency would be a pretty serious blow to anyone owing fixed-rate debt.

[/ QUOTE ]

That's assuming they couldn't refinance of course. Most home mortgages (the majority of consumer debt) do not contain prepayment penalty clauses, so if it happened, which is highly unlikely, people would freely refinance, just as they did when interest rates dropped from 2000-05.

[/ QUOTE ]

Good point.

[Zygote]

[ QUOTE ]
I'm sure the usual gang will chime in, but you're basically correct. Hard money/no inflation is great if you have money, it sucks if you don't, as credit markets pretty much dry up. Ours is a credit based economy.

[/ QUOTE ]

There are limited resources in the world. How do your "credit based economies" account for this?

Also "credit based economies" are only useful so far as they have credit. Therefore, if they practice what you preach there will eventually be a huge spike in interest rates, as the country consumes more than they have, and lenders become aware and demanding.

[ QUOTE ]

..and were pretty much decided in favor of the soft money faction. The hard money faction does have a point, the value of money does decline over time, but the consequences of hard money are pretty harsh as well, and the world has decided that the downside of soft money is the lesser evil.

[/ QUOTE ]

Care to make a stronger point for a statement deserving as much?

[irunnotgood]

If you want to reward borrowers and punish savers then fiat money is fine.

[Zygote]

[ QUOTE ]
So I was recently sitting and speaking for a few hours about economics with one of my friends and childhood teachers. The case of a mortgage came up and he went off explaining about how, because of inflation, holding a mortgage was beneficial to the borrower.

You see, when the borrower first gets the loan, it may be a $1200 a month payment. Now, this is a fixed rate, 30 year loan in our example. Let us say that the borrower brings home, after taxes, $3000 a month. Now assuming a rate of 4% of inflation, and assuming that the borrowers pay rate stays constant in the face of inflation, than that means that in 15 years, the borrowers take home pay will have increased by a factor of 1.8 (using the compound interest formula) to $5402 a month. All the while, the mortgage payment remains constant at $1200. What's more, the owner can take the extra $, which are inflated from the original value of the loan amount and pay them into prinicple, thereby paying off the loan sooner.

There are a lot of other factors to consider. However, I think that a very strong case can be made that inflation benefits the borrower, i.e. the consumer. The opponents of the FED will constantly talk about inflation being a "tax," but overlook the fact that it actually is a tax in favor of a borrower, who is spending money. They often say that the tax is against the lender and investor.

Does the investor represent a market or does the consumer represent a market? In a market, does the investor create the market or does the consumer? How would a market function that constantly concentrated money in the hands of investors and not consumers? I think there would be a shortage of consumers.

There seems to be a contradiction in the logic against arguments railing against an inflationary monetary policy. Something that I often hear in conjunction with such arguements is that it is a bad thing to concentrate wealth into the hands of a minority. No inflation, they say, is essential for keeping the value of money in the hands of the many. It seems, however, that the effects of inflation being of benefit to the borrower in fact serve to prevent the accumulation of capital to the hands of the few, creating more consumers and therefore more market.

[/ QUOTE ]

the problem with your point is it doesn't produce iterative benefits.


Borrowers exploiting this fact are doing so at the expense of other real people. These people will eventually demand overtly high rates of interest due to mistrust and flush tons of people out of the credit market.

Do you support legislation for direct pre-income tax transfers from creditors to borrowers? Why yes or why not?

[ QUOTE ]
Something that I often hear in conjunction with such arguements is that it is a bad thing to concentrate wealth into the hands of a minority. No inflation, they say, is essential for keeping the value of money in the hands of the many. It seems, however, that the effects of inflation being of benefit to the borrower in fact serve to prevent the accumulation of capital to the hands of the few, creating more consumers and therefore more market.

[/ QUOTE ]

Inflation benefits the minority in this sense..

As the dollar devalues imports will be relatively more expensive and other nations will get a discount on US assets. These other nations are able to take advantage of our slow down in purchasing power through their increase, and make us work as hard as if prices were one day instantly slashed abroad for foreigners purchasing our goods.

The US business in the export industries will see huge jumps in their income. Since they use this income to pay for expenses still priced in US dollars, which are not yet priced to their value, the receivers of these dollars will eventually lose their purchasing power when prices eventually rise in the US and this especially true if the receivers are dependent for goods abroad.

Since prices of goods abroad are more heavily increased, all Americans and businesses depending on imports from abroad are heavily expensed and the economy suffers from a lack of international specialization.

Also the money doesn't spread homogeneously nor do prices rise in tandem (other than from the perspective of foreigners). Throughout the process the people who trade dollars in for goods early on benefit greatly at the expense of people trading real resources for pretty paper back by less and less creditable tax payers.

Furthermore, securities priced in US dollars like stocks/equities can rise in value as the dollar depreciates and this increase the value of shareholders. If they use these increases to pay expenses or buy goods early on they are doing so at the expense of the late receivers of those dollars.

As a matter of fact, the people who borrow a lot and spend a lot during inflation gain at the eventual expense of the entire credit community. This process also greatly distorts market forces by rewarding incorrect uses of resources throughout. This has great consequences on the ability of people in the economy to calculate correctly and the general economy forever more will suffer as a result.

[lehighguy]

Interest rates will rise as investors factor in higher expected inflation, making new mortgage issuance more expensive.

[adios]

[ QUOTE ]
[ QUOTE ]
Any fixed-rate mortgage loan includes an amount sufficient to compensate for predicted inflation. Only to the extent that actual inflation exceeds what was expected is there a transfer to the borrower (and vice versa if inflation is less than expected.)

It is the case though that a sudden shift to a gold standard or similar inflation-free currency would be a pretty serious blow to anyone owing fixed-rate debt.

[/ QUOTE ]

That's assuming they couldn't refinance of course. Most home mortgages (the majority of consumer debt) do not contain prepayment penalty clauses, so if it happened, which is highly unlikely, people would freely refinance, just as they did when interest rates dropped from 2000-05.

[/ QUOTE ]

They can refinance if among other things their credit rating is good enough and there's sufficient liquidity to fund refinanced loans. Given the current debacle with sub prime lending while waiting for the "other shoe to drop" with loans for over priced real estate to people with good credit IMO it's not far fetched to believe that we won't see something like 2000-2005 for quite some time. And if we're talking about switching to a full reserve system where the currency is backed by a commodity, I think we could expect to see loans a lot harder to come by than they are now or have been. Could be convinced on that though.