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Who Benefits from Inflation?
06 Jun 2022
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Inflation will be combated, but not in full force due to competing interests regarding its excessive decline.

At the end of the 13th century, the massive issuance of coins with diminishing silver content by the French King Philip IV led to high inflation at the beginning of the 14th century. As has been the case in so many other eras, the poorest people (who at that time represented the vast majority of the population) suffered intensely from inflation, especially from rising food prices, and a popular revolt in 1306 forced the king to leave his palace in the Louvre and take refuge in the Parisian fortress of the Templars. In addition, the high nobility and the clergy were also badly damaged by inflation: they had lent "high quality" money (high silver content) which was returned to them in money with hardly any silver: in other words, inflation was also detrimental to the lenders. The situation was finally resolved with the arrest of the Lombard merchants, the confiscation of the Jews' goods and their subsequent expulsion, the confiscation of the Templars' goods, and the abolition of the order. But did anyone benefit from this calamity? Well, perhaps those who had borrowed in "good money" and paid back the loans in "bad money" and King Philip IV and the French proto-State come to mind as a great beneficiaries. That is why Dante banished this king to hell by calling him "the great counterfeiter."

When we analyse the current issue of inflation, its societal damage also becomes evident. Inflation erodes purchasing power, especially if it exceeds the rise in wages (the current situation), which is particularly harmful to the poorest households, which have little savings to cope with this situation. It is unsurprising that along with high food inflation, which in many emerging countries accounts for more than a third of the consumption basket, social uprisings (not unlike the one in 1306) are often observed. Inflation also hurts many companies who face cost increases either because of the sharp rise in industrial prices or because of increases in labor costs (these trends are particularly marked in the USA) and are unable to transfer these to their selling prices.  Moreover, countries that have lent huge sums of money in times of low inflation, such as China, which has channeled some three trillion dollars of loans to the US in different concepts, will see this money devalued via inflation (it will be returned in "bad money"), which will generate one of the most substantial losses in history.

Now, does anyone stand to gain from this situation? The answer is yes, today a new Philip IV exists. On one hand, States usually increase tax collection in inflationary periods. This is mainly because we pay taxes after assigning a tax-free allowance, equivalent to a perception of the minimum amount that a household needs to meet its essential expenses. Common sense dictates that these allowances should increase when inflation strikes, but nevertheless States are reluctant to do so, in order to collect more without having to increase taxes, despite the result being essentially the same. Spain's case is quite evident. Furthermore, since the analysis of a State's debt is carried out by comparing public debt against nominal GDP, this means that the size of the economy grows in line with the real growth of GDP and also with its deflator, a very large part of which coincides with inflation.  Thus, for example, if Spain's GDP grows by 4% this year and the inflation-deflator is 6% on average, GDP will have grown by 10%, which means that public debt over GDP will almost certainly have fallen. This is the process that the US used after World War II to pay off the debt accumulated during the war. Hence, debt close to 110% of GDP in 1945 fell to 60% in just ten years, mainly due to the mechanism described here.

There are companies that also benefit, like the borrowers of medieval France. They are those that have proceeded to issue long-term fixed-rate debt. They therefore benefit from lower interest rates than the market for a good period of time, a period in which their revenues and profits can rise with inflation, so that they "deflate" the value of the debt, resulting in a gain for shareholders.

Finally, there are also individuals who win: those who have proceeded to finance their mortgages at a fixed rate with long terms. If a person bought a house last year by taking out a 25-year mortgage at a fixed rate of 2%, and we assume that their salary will increase with an average inflation rate of 2% in the medium term, then by the time they pay off the house their salary will have risen by 50% progressively over time, while their mortgage payment will remain stable throughout the period. They have also deflated their debt and thereby gained.

As we explained in a recent column, the forces driving inflation are slow and sometimes invisible. Inflation will be fought, but not in full force, because not everyone wants it to fall too much. There are actors who stand to benefit from inflation...

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