Of Inflation and Borrowing

 

Photo by Mar Cerdeira on Unsplash

Inflation is good for borrowers?  Really?  So some say.  The case goes like this:  when the borrower receives his loan for so much, he promises to pay it back with money that would buy so much, but after inflation the money he uses to repay the loan will buy less.  He repays with cheaper money.  The lender gets his money back, but it is worth less than it was when he lent it.  Hold that thought, because that is the weakness in the case.

This inflation “benefit” may work for borrowers who already have loans, with a fixed rate that they can handle.  For all others, however, inflation raises the costs of everything, including borrowing.  How long will lenders be willing to lose value in the loans they make?

Think of it this way.  Does inflation work for people who sell things?  Maybe for their current supply, but their new supply will cost them more, eating into what they earn and raising the cost of what they try to sell to the next potential buyer.  The same reality is true for people who “sell” money, which is what lenders do. 

As we buyers know, inflation does not work well for buyers.  We face ever higher prices for the same things.  The same is true for people who “buy” money, which is what borrowing is.

New borrowers will find interest rates, the price of borrowing, rising with inflation, too.  That could put borrowing out of reach for some, just as it does for buying a house, a car, or work tools.  Businesses that need to roll over their existing loans could find the new loan more expensive, maybe even too expensive.  People who want to refinance their mortgage may find the new rate makes that much less attractive.  Floating rates, like credit card rates, will rise, so the cost of the products charged to the card will not be the only higher costs that card users face.  In short, only some borrowers, a declining some, may benefit from inflation, and only for a time.

Today’s money rests on trust, whether we talk of paper money, coins, or financial accounts.  We sell our time, our goods, our services in exchange for money.  That money is a promise that we can use it in trade with someone else for something of comparable worth.  When we accept money in payment, we in turn are making a loan to someone who has already received our goods, or services, or time.  All we got was a promise, which we trust we can exchange with someone else.  Inflation undermines that trust.  We receive a $100 payment of money which because of inflation may soon buy only what $95 used to buy.

Even governments will face the challenge of higher costs.  Sure, they will be paying back existing government debt with devalued money, but their new borrowings will carry a higher price tag, as will the things that governments buy.  I was going to say, look in the mirror if you want to know who will pay that higher cost of government debt, but if you do, have your children looking with you.