Inflation isn’t just bad for savers, it hurts debtors too

Every time the inflation numbers come out, we are told that, while the news is terrible for savers, it is good news for debtors. But is it really? This idea that inflation is a good thing for those that owe money is based on the idea that inflation devalues the debt or at least that the asset against which the debt is held goes up in price so much that the debt becomes of no consequence.

Consider the case of someone who bought a house in the early 1970s. Inflation soared. But so did nominal wages and house prices. So by the 1980s he was in a pretty good position. His house would have been worth double or triple the nominal sum he paid for it and his wages would have risen by a similar amount. His mortgage debt would have become almost irrelevant to his finances.

But things aren’t the same these days. Inflation might be going up but house prices aren’t (so a mortgage isn’t making you any money) and neither are wages. That means that inflation is no better for debtors than for anyone else. Today’s inflation eats away at their disposable income (they have to spend more on food and fuel) but they aren’t compensated by rising house prices or by rising wages – instead of being easier to meet, their mortgage payments get harder to meet as their real income continues to fall. Inflation can’t deflate debt all by itself. Only inflation alongside higher asset prices and higher wages can do that.

So what next? There is a view that real wages will soon start rising again and that house prices will do the same. Regular readers will know my views on the latter but I’m no more confident on the former. I interviewed Aberdeen’s Bruce Stout this time last year. He noted that real wages have gone nowhere in the UK for a decade and forecasts that, thanks to the ongoing credit crunch and the economic shift from west to east, they wouldn’t for another decade. Go up to Stockbridge (a fashionable part of Edinburgh) today, said Bruce, and “I can guarantee that Costa will be full of people having £2 coffees and £3 paninis”. They won’t be there in a decade.

Truth is that “if you go on a credit binge for 20 years, there is going to be one heck of a howl” as it comes to an end. People have “no idea” quite how much their living standards will have fallen by the time the debt problems in the West have finally worked themselves out.

Bruce’s forecasts have come pretty good so far. As long as Bruce is right – and real wages continue to fall – Britain’s inflation problem will be no better for debtors than it is for savers.