Who Does Inflation Hurt Most?

Who does inflation help and who does inflation hurt?

When we first think of inflation we assume that it will affect all people equally. After all if everyone is using the same dollars wouldn’t everyone be affected equally? The fact of course is that everyone isn’t affected equally.

Our second assumption might be that the poor would be hurt the worst because they earn minimum wage and everything they buy is getting more expensive. However, if the minimum wage is indexed to inflation they would about break even. So interestingly if the minimum wage earners are also deep in debt inflation actually helps them.

The reason for this is that debtors borrow valuable money and the number of dollars they must repay is fixed. So over time the value of the dollars they must repay is less and less (so they are easier to obtain than if the value of the dollar wasn’t inflated away.) This is called repaying with “cheaper dollars”.

However, bigger beneficiaries would be the average middle class person with a large mortgage because the debt is for a longer term so inflation has longer to work it’s “magic”.

On the other hand, the biggest losers due to inflation are those willing to lend money. An extreme example would be during the hyper-inflation of 1923 in Germany. If you had loaned a friend enough money to buy a car in early 1923 and he had repaid it at the end of 1923 you might have been able to buy a box of matches with it. So it is easy to see that the borrower got a car and he was able to repay it with pocket change. The lender of course was the big loser.

At first this looks like the ultimate Robin Hood scheme, robbing from the rich bankers and giving to the poor borrowers. However, the other big losers those on fixed incomes like the elderly and anyone whose income isn’t indexed to inflation.

Inflation affects them especially hard because the prices of things they buy go up while their income stays the same. In addition, the poor are generally renters so they don’t even benefit from a “cheaper” mortgage while they are paying higher prices for their groceries.

Also even though their wages may be indexed to inflation there is a time lag since it is usually only re-indexed once a year. During this time they are on the old wages while prices for things they buy have already gone up.

Interestingly the biggest debtor in the world is the US government and thus it is also the biggest beneficiary of inflation.

And not coincidentally the Government is also the one who controls the money supply and thus inflation.

In a way, inflation works as a hidden tax because the government borrows money from investors. It spends this valuable money and then gets to pay back its debt with cheaper dollars.

The poor unsuspecting investor who is convinced that Government notes, bonds and T-Bills are “Low-Risk investments” accepts these dollars at face value but before long realizes that they won’t buy as much as the dollars they loaned to the government in the first place.

Generally, the Government walks a tightrope though, it can’t inflate all its debt away too quickly, without destroying the economy, so it faces a constant balancing act.

One big disadvantage of inflation is the fact that it discourages lending (smart banks need more interest to make up for the lost value). This prices some borrowers out of the market making loans too expensive.

Inflation also makes planning for the future more difficult, so businesses are less likely to take risks. No risk means no advancement which stifles the entire economy.

On a small scale lenders are the losers from inflation and borrowers are the winners but on a bigger scale the biggest beneficiary is the Government and the overall economy is the biggest loser. Other losers are those on fixed incomes and those who are priced out of the loan market.

 

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Comments

  1. Greg Benz says

    Grammar correction: one cannot “loan” money, because “loan” is a noun, not a verb. One can lend money.

    • says

      According to Dictionary.com “Usage note
      Sometimes mistakenly identified as an Americanism, loan as a verb meaning “to lend” has been used in English for nearly 800 years: Nearby villages loaned clothing and other supplies to the flood-ravaged town. The occasional objections to loan as a verb referring to things other than money, are comparatively recent. Loan is standard in all contexts but is perhaps most common in financial ones: The government has loaned money to farmers to purchase seed.” http://dictionary.reference.com/browse/loaned

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