Bonds Are Not Forever: The Crisis Facing Fixed Income Investors

CHAPTER 8

INFLATION

A Brief History

Inflation is the hidden tax that eats away at the value of money. High inflation distorts decision making in numerous ways, and because it’s less stable than low inflation, it adds uncertainty to most economic decisions about money. Low and stable inflation is uniformly regarded as conducive to economic growth. Since the very beginning of the use of money as a medium of exchange, governments have been aware of the potential for inflation to slowly, or sometimes spectacularly, destroy savings. There exist numerous examples throughout financial history of currency debasement—often, this was to the perceived benefit of the government through a reduced real value of debt owed to private lenders. Eventually, investors demanded adequate compensation for inflation and federal revenues and outlays began to be indexed for inflation. Even so, prior to that, inflation usually hurt just about everybody.

Although accurate data are obviously difficult to obtain farther back than three or four centuries, history going back to Roman times contains examples of currency debasement during which coins issued by the government were minted with ever decreasing percentages of the precious metal from which their value was derived. In other cases, older coins would gradually lose weight and metal content through wear and tear; as new coins were issued with a metal content that conformed to the original, they would be hoarded by consumers and not used because of their ...