THE THREAT OF INFLATION 43and investors like you who see the value of your assets decline.
Again a simple example makes the point.
Assume a debtor bought a $250,000 home in 2007 with a
$50,000 down payment and a $200,000 mortgage with a low
teaser rate. Today, the home is worth $190,000, a 24% decline
in value, but the mortgage is still $200,000 because the teaser
rate did not provide for amortization.
This homeowner is “underwater” — the value of his home is
worth less than the mortgage he’s paying — and he’s slashed his
spending in response. In this scenario, assume there is another
individual, a saver, with no mortgage and $100,000 in the bank
who receives no interest under the Fed’s zero interest rate policy.
Suppose a politician came along who proposed that the
government confiscate $15,000 from the saver to be handed
to the debtor to pay down his mortgage. Now the saver has
only $85,000 in the bank, but the debtor has a $190,000 house
with a $185,000 mortgage, bringing the debtor’s home above
water and a giving him a brighter outlook.
The saver is worse off and the debtor is better off, each
because of the $15,000 transfer payment. Americans would
consider this kind of confiscation to be grossly unfair, and the
politician would be run out of town on a rail.
Now assume the same scenario, except this time, the
Federal Reserve engineers 3% inflation for five years, for a total
of 15% inflation. The saver still has $100,000 in the bank, but
it is worth only $85,000 in purchasing power due to inflation.
The borrower would still owe $200,000 on the mortgage,
but the debt burden would be only $170,000 in real terms after
inflation. Better yet, the house value might rise by $28,000 if
it keeps pace with inflation, making the house worth $218,000
and giving the debtor positive home equity again.
The two cases are economically the same. In the first case,
the wealth transfer is achieved by confiscation, and in the
second case, the wealth transfer is achieved by inflation. The