Implications of high inflation on borrowers/lenders

Discussion in 'Economics' started by kxvid, Feb 26, 2009.

  1. kxvid


    Obviously, if there is a period of high inflation people with fixed rate loans make out very well. That is because they will be paying back their loan in inflated dollars.

    But economics teaches us that there is no free lunch. While the borrower makes out well, another party suffers. My question is will banks suffer and possibly fail during periods of high inflation that made a lot of fixed rate loans? Or is it another party that suffers such as the FED who made loans to banks and gets paid back in inflated dollars?
  2. piezoe


    In the past, mortgage lenders counted on the average mortgage being rewritten about every seven years on average, as very few people buy a home and live in it for 15 to 30 years. generally inflation is a friend of those in debt including governments and deflation is a friend of those with stores of cash.

    The US saves billions by "cheating " on the real inflation figure because TIPS and entitlements are indexed to inflation.

    Those few with low interest 30 year mortgages that keep their mortgages for the entire term end up paying back dollars with far less buying power than the ones they borrowed.

    If you are heavily in debt, for example the US, it is easy to understand why deflation is feared.

    What many don't grasp in the link between deficit spending and inflation.

    Even here on ET, where most should no better, there are endless posts calling for lower taxes. Obviously if you increase spending and lower your income the difference has to be made up by borrowing. In the case of governments it is political suicide to call for higher taxes, consequently indirect taxation through inflation replaces direct taxation. In reality there is little difference between the government taking five dollars out of your pocket directly or making the ten bucks in your pocket worth only 5 in buying power. But only the latter method of taking your money is politically acceptable.

    Those calling for lower taxes should instead be calling for reduced spending. You can't have deficit spending with borrowing and lower taxes forever without also having inflation. It is true however that the burden of government debt may be somewhat redistributed depending on whether it is paid back through direct taxation or via inflation.
  3. And if the Gummint/Fed didn't "screw with the money", there would be neither inflation nor deflation.

    But Nooooo.... The Powers confiscate our wealth with a "below the radar" inflation... right under our very noses... and nobody complains.... because most don't "get it". :mad:
  4. kxvid


    Thanks for the replies, but I wish someone could give a more definitive answer.

    Say a bank borrows at 0.1% from the fed and uses the money to make a 30 year home loan to a prime borrower. Say the rate is 5.5% fixed. Now assume the borrower pays the loan diligently not missing a payment for 30 years, no refinances etc. What would be the terms of the loan the bank took out from the fed? Would they only have to pay the fed 0.1% over thirty years? Meaning 5.4% interest is pure profit for the bank? What happens if rates went up, would they have to pay the fed a higher interest rate, or would loans taken out during low interest rates stay the same?

    can anybody point me in the right direction?