Whenever there are huge debt loads, inflation kicks in as a helpful aid to lowering debt. It's simple. If the dollar is devaluing, you pay back in new, cheaper dollars.
So say you owe $15,000 on your credit card right now. If inflation kicks in, say it goes up 20%, then your 15 grand just became a 20% smaller burden on you. You would pay it back with today's devalued dollars.
Now, say you are a government with a 14 trillion dollar debt ceiling. Inflation at 20% would reduce your load by almost 3,000 billion dollars.
For a while, I was pretty puzzled why Obama would propose a stimulus plan, and why he would hit the treasury up for more printed dollars to create jobs. It makes sense. Doing so would increase inflation, reduce relative debt loads, and also spur consumer spending and jobs. But undoubtedly at the cost of the strength of the dollar.
I can see why he does it, and I can see the risk to the uninformed investor. The U.S. could go bankrupt doing this, and all that is needed is for that to happen is if international investors stop buying U.S. Treasuries. But they won't abandon treasuries because if the dollar plummets, their previous debt gets paid back in increasingly worthless dollars.
So the U.S. economy and the world are in a mexican standoff. $6 trillion in treasuries owned by China. China is buying up Japanese yen (thus the increase in the yen). If China abandons buying U.S. Treasuries, the U.S. could go tits up, and then China loses six trillion.
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The repayment of debt includes both principal (which you correctly state is worth less in an inflationary environment) and interest.
In an inflationary environment, the interest rate increases to offset the decline in principal value. So, high inflation, high interest rates, high cost to repay the debt.
Now, that only works for new debt. The old debt is fixed, so you can play bait and switch. Issue a lot of long-term debt at low interest rates when inflation is low, and then whamo ... stimulate the heck out of the economy and drive up inflation.
However, that only works once, and high inflation has a negative impact on the economy.
"For a while, I was pretty puzzled why Obama would propose a stimulus plan,"
Simple: The US is at risk of going into a Deflationary period. Deflation is a lot worse than inflation. Deflation is almost on par with hyper inflation.
"But they [international investors] won't abandon treasuries because if the dollar plummets, their previous debt gets paid back in increasingly worthless dollars."
You only have to be the first guy out, and then who cares what happens to the US dollar. In fact, you don't even have to sell the US Treasuries. All you have to do is short the dollar.
Iakot - the phrase "shorting" anything is too crazy for me. However, effectively I guess I am shorting treasuries in my own mind.
still have one question, if something is traded in US dollars and the dollar becomes "worthless" what does that make whatever is being traded in US dollars?
Nobody is going to stop buying US dollars, it is the safest place to keep your money
Our debt is large, however our debt to GDP is low, lower than just about everybody. We can racked up quite a bit more debt
on a side note, i am not a fan of having two seperate blogs
"if something is traded in US dollars and the dollar becomes 'worthless' what does that make whatever is being traded in US dollars?"
The only thing that becomes "worthless" is something that is a proxy for US dollars - basically debt. Everything else becomes very expensive.
For instance, your house is traded only in US Dollars. You don't sell it for CDN, Yen, Euro, or Sterling. Only USD. However, the house has intrinsic value separate and distinct from the value of the USD. So, if the USD becomes "worthless", you merely ask for more USD in order to entice you to sell it.
So, if the USD is only worth 1/100th of its current value (worthless in some people's minds), then you would ask for 100 times more than current value. That way, you can use the USD to buy something else that has increased in cost by 100 times.
In an extreme case, the USD would be declining so fast that as soon as you sold your house, you would take the USD and buy something else so you could retain the value. People start spending so much of their time getting rid of USD (converting it to goods) that it starts disrupting productivity (spending too much time waiting in line to buy goods, not enough time working). And that is hyper inflation.
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