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Soul Reaver

Inflating Away Debt

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Can someone explain to me how debt is erroded by inflation?

I would recommend having a look at Wikipedia to get a good idea of what inflation is, how it erodes debt all depends if the debt in index linked.

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I would recommend having a look at Wikipedia to get a good idea of what inflation is, how it erodes debt all depends if the debt in index linked.

Yeh I read that but didn't really understand it.

Increases in the price level (inflation) erode the real value of money (the functional currency) and other items with an underlying monetary nature (e.g. loans and bonds). However, inflation has little effect on the real value of non-monetary items (e.g. goods and commodities, gold, real estate, companies´ capital and profits,

Debtors who have debts with a fixed nominal rate of interest will see a reduction in the "real" interest rate as the inflation rate rises. The “real” interest on a loan is the nominal rate minus the inflation rate (approximately [33] ). For example if you take a loan where the stated interest rate is 6% and the inflation rate is at 3%, the real interest rate that you are paying for the loan is 3%. It would also hold true that if you had a loan at a fixed interest rate of 6% and the inflation rate jumped to 20% you would have a real interest rate of -14%. Banks and other lenders adjust for this inflation risk either by including an inflation premium in the costs of lending the money by creating a higher initial stated interest rate or by setting the interest at a variable rate. As the rate of inflation decreases, this has the opposite (negative) effect on borrowers.

I thought inflation DID affect the value of houses etc because if house value is at say 250k and then you have 10% inflation you have a nominal house value of 240k after taking into account the inflation?

Edited by Soul Reaver

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Can someone explain to me how debt is erroded by inflation?

OK, say you had a debt of £100, and you earn £10 a week. There is only one item in this 'world' that you can buy, food. The contract of your debt means you have to repay £1 a week for 100 weeks. That means you can spend £9 a week on food, say that buys you 9 units of food. The person you owe the money too gets his £1 and can buy one unit of food per week.

Then someone prints a load of money. Incomes and prices double as a result, but your debt is fixed due to the contract. So you earn £20 a week, and pay £1 a week for you debt, leaving you £19 to spend on food. The price of food has doubled, so you can now buy 9 1/2 units of food. The creditor with his £1 can only buy 1/2 a unit of food.

So the real amount of debt you have to pay has fallen by 1/2 a unit of food a week.

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If you apply a value of 7% to something for 10 years you will either double or half it.

If we have 7% inflation - and this needs to include wages ideally... then after 10 years the amount of 250k that really stung as a debt, and would have bought you 250 thousand loaves of bread, will now only buy you 125 thousand loaves of bread, as at 7% they have doubled in cost over 10 years.

Of course if your wages haven't kept up, then although your mortgage costs you less loaves of bread a month to service, you can only afford half the number of loaves of bread you could when you bought it.

That there is the gamble... will your wages keep up with inflation. I suspect the answer is likely to depend on whether you work for someone else or not.

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It isn't, under this system.

Are you saying the debt in indexed linked or that there is no wage inflation or a both or something completely different?

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Can someone explain to me how debt is erroded by inflation?

The way I look at it (the simple way) is if I owe you ten quid, and come next year ten quid won't even buy you a loaf of bread, what I owe you has been eroded by inflation. Or a thousand quid, or a million. You just have to wait long enough, especially if Merv's looking after interest rates.

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As far as I can see, if we have wage inflation then the debt can be more easilly paid off, because of the ability to pay down the debt quicker with your bigger salary.

Without wage inflation, everything is becoming more expensive and you are less able to pay down debt, you are effectively....f***ked.

Edited by TheCountOfNowhere

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Are you saying the debt in indexed linked or that there is no wage inflation or a both or something completely different?

The inflation is additional debt because it's being borrowed at interest.

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inflation is fools gold tbh, as a govt if you have inflation you have to borrow even more money to pay for the things you buy, you may also have borrowed money on an index linked basis and have loads of commitments such as pensions and benefits which are index linked.

As an individual you lose from inflation unless your wages keep up, however the company you work for becomes less competitive through having to pay you more and pay more to its suppliers, the end result being that the company will move elsewhere.

so basically inflation can only inflate away debt if wage inflation follows suit, but this will lead to high unemployment and much greater govt. debt.

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Then someone prints a load of money. Incomes and prices double as a result,

I think we all understand how a personal debt can be eroded by price and wage inflation.

What is less clear is how a national debt can be, in a scenario where wages are not rising.

Of course a similar "turnover" of goods in an inflated economy will result in an increased income for the government,

but what when the cost of living increases and erodes the discretionary spending of a population with static wages?

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Mark my words.................

There will be NO positive wage inflation without positive interest rates......

If you/we/i am to ever see wage inflation north of RPI, even 4% plus per annum for a couple of years, then base rates will move north...

Interest rate rises will cancel out wage inflation for the over-indebted by way of neutralising spending power but will help inflate away debt for the over-indebted..

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It depends on what you mean by "inflation".

Inflation can mean several things, although they are often inter-related:

* Inflation in consumer prices (or retail prices) for goods and services (often known as CPI or RPI)

* Inflation in labour costs or wages

* Inflation in corporate earnings/profits

* Inflation in the money supply

In the past, when the majority of the economy was domestic, and domestic labour was a substantial part of the variation in the cost of goods and services, then there was a strong link between all of these. Today, when we import a lot of things, especially food, clothing, oil/petrol/gas, the connection is much weaker and the different types of inflation can move to a degree independently.

Consumer price inflation does not have any affect of the ease of repaying debt (although it make repaying index-linked debt harder, since index-linked debt is usually linked to RPI)

Wage inflation DOES make it easier to repay personal debts, as the increase in income makes it the debt relatively smaller.

Corporate earnings inflation DOES make it easier to repay corporate debts, as the increase in income makes it the debt relatively smaller.

Inflation in wages and corporate earnings increase the tax receipts and so make it easier for a government to repay its debts by making them relatively smaller.

Over much of the past 10y or so we have had deflation in imported goods and inflation in domestic wages and earnings, making all debt easy to repay. So we borrowed and borrowed and borrowed.

However now we have a situation where import commodity prices are increasing (inflationary) but wages and earnings are static/falling (deflationary) which has exactly the opposite affect. It looks like inflation from RPI, but the net affect is to make it harder to repay debts.

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Can someone explain to me how debt is erroded by inflation?

Soul Reaver, there's a simple answer...and then there's a long complicated argument inducing answer!

The simple answer assumes that inflation increases wages but doesn't affect debts. So income goes up, but debt is fixed. Consequently the debt, relative to income, is eroded.

In other words, someone has a £100,000 mortgage and a £20,000 salary, so their mortgage is 5 times their salary. But a few years of 1970's style inflation would see their salary double to £40,000. The mortgage is still fixed at £100,000, so it's now just 2.5 times their salary. Inflation has eroded their debt relative to their income.

The same principle works for government debt because, in the same way that inflation is assumed to drive up wages, so it also drives up government's tax take.

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....compounded debt interest together with below real inflation pay rises is killing debt erosion for most of us.

So to beat the trend, have as little debt as possible at the lowest rate possible, and if your pay rises are less than the real inflation rate learn to spend less/live on less. ;)

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That is a very good point and a natural consequence of the BoE only targetting wage inflation.

Targetting wage inflation? I think you will find they use figures supplied by the ONS who are as vigilant as the B of E.

"Salary into the bank" must exclude all sorts of things

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Can someone explain to me how debt is erroded by inflation?

inflation = more money in circulation = value of debt as proportion of money in circulation reduced.

A minor side-effect is that savings are likewise devalued ...

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Targetting wage inflation? I think you will find they use figures supplied by the ONS who are as vigilant as the B of E.

"Salary into the bank" must exclude all sorts of things

So in essence keeping the young with no cash but salaries indebted, keeping the indebted with salaries poor, but keeping the not indebted with savings/and/or salaries better off , not in debt with savings/salaries is king....................

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If the OP was confused before, I'm sure this thread has provided the simple explanation they were after...

Quite. I'd like to stir some faeces into the pot by mentioning that debt isn't eroded by inflation (money printing) - at all - if your debts are denominated in a foreign currency, which is more common than you might think.

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Can someone explain to me how debt is erroded by inflation?

Don't see how debt is eroded by inflation at 5%. Look at 7k credit card debt charged at 26% APR- would you say over 4 years the real debt decreases on this? the bank always win

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