Who Loves Inflation?

| Wed Nov. 24, 2010 3:02 PM EST

Karl Smith:

Reihan Salam has written a bunch of stuff I have been meaning to respond to but haven’t. The only point I want to address because its real quick is that inflation does not erode savings. It only erodes cash and the value of long bonds taken out before the inflation set in. However, the Fed is buying long bonds and propping their value. The only thing that is eroded in this scenario is cash.

Back in days of old, poor farmers loved inflation because it allowed them to pay back their loans with cheaper money. Rich Wall Street bankers hated inflation for the same reason. From this came populist demands for free silver at 16:1, crucifying mankind on a cross of gold, etc. etc. But none of this really matters any longer because interest rates all react to inflation: in the long term interest rates generally move up and down with inflation expectations and in the short term they're keyed to LIBOR or the prime rate or some other inflation-sensitive variable.

But there's one exception: fixed-rate loans. In particular, fixed-rate home mortgage loans, of which there are still quite a few. So for existing homeowners with traditional 30-year fixed-rate mortgages, higher inflation would be great. And for the bankers and investors who hold those loans, it would suck. Inflation may not erode savings, but it does erode the value of a fixed-rate mortgage, which means this whole argument isn't quite a dead letter yet — and bankers and the common man are still on opposite sides. Right?

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