The first trick to understanding inflation is recognizing that every transaction has two sides.
The second trick is to pay no attention to the dollar amount but use purchasing power instead.
The third is to notice after-tax purchasing power instead of pretax.
All economics is about trade-offs. When the government borrowed a billion dollars in 2012 in exchange for a 10-year bond, they received $1 billion worth of purchasing power. In 2022 the bond comes due, and they repay $1 billion, then worth only $800 million.
The government has a locked-in win by borrowing. The total win for the government is $300,000,000 per billion borrowed. That is a 2.66% return in their favour. The average rate on new issue 10-year bonds in 2012 was 1.80%.Easy calculation from there.
If you can profit without risk by borrowing, you would be foolish to not do it.
Governments are frequently inept and sometimes corrupt, but even someone as dumb as a bag of hammers would choose the inflation option.
How did the lender do? Not so well. This is a zero-sum game. The loser loses what the winner wins.
Many people think buying physical assets that they too could win in the long run from inflation. That analysis is too superficial. Things you must also think about.
Governments win with inflation to the point they would be stupid not to do it.
Governments win what others lose.
Borrowing during inflationary times works for the government but not reliably for the people.
Owning cash-denominated assets is likely to hurt you.
This is one of those cases where you will not catch on using intuition. That’s how the government gets away with it. Use a spreadsheet and work it out. Inflation makes the economy more fragile. Take no unnecessary risk.
If the short-run doesn’t work, the long-run won’t matter.
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I build strategic, fact-based estate and income plans. The plans identify alternate ways to achieve spending and estate distribution goals. In the past, I have been a planner with a large insurance, employee benefits, and investment agency, a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business. I have appeared on more than 100 television shows on financial planning. I have presented to organizations as varied as the Canadian Bar Association, The Ontario Institute of Chartered Accountants, The Ontario Ministry of Agriculture and Food, and Banks – from CIBC to the Business Development Bank.
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