Induced inflation feared as way to cut debt

As the White House tried one more time Thursday to galvanize support from a recalcitrant Congress for a deficit commission to tackle the nation’s dangerously bloated debt, fears are growing that the United States will once again resort to printing money and ginning up inflation to resolve its debt problem.

While accelerating the printing presses could do irreversible damage to the dollar’s international reputation and the U.S. economy, history suggests that this is the way Washington will go to avoid the political pain of having to raise taxes and cut spending on popular programs such as Social Security, defense and Medicare.

Some notable economists argue that such a move would avert a debt crisis like the one confronting Greece and other European countries that have been unable to reduce spending because of strong public resistance.

Political leaders and the Federal Reserve, which is charged with printing and circulating U.S. dollars, strenuously deny that they have any intent to “inflate” out of the debt.

Nevertheless, a sign emerged this week that the prospect is increasingly becoming an issue in internal Fed deliberations.

The Fed’s most strident inflation fighter, Thomas Hoenig, president of the Fed’s Kansas City reserve bank, warned on Tuesday that “short-term political pressures” are prompting Congress to take a risky gamble by continuing to borrow at unsustainable rates rather than address the deficit problem and he expects political leaders to be “knocking at the Fed’s door” to demand that it print money to pay for the debt.

This path “inevitably leads to financial crisis,” Mr. Hoenig said, while the inflation it would spawn would threaten American living standards and destroy the independence and credibility of the Fed, whose most important job is to prevent inflation.

Chairman Ben S. Bernanke and other Fed officials have been more vague and less urgent in warning against the dangers of political pressures, leaving Mr. Hoenig as a lone dissenter in the last meeting of the Fed’s monetary policy committee in urging more vigorous action to move against inflation.

But despite some resistance and wariness at the Fed, a growing number of Wall Street gurus expect the U.S. to adopt at least an unofficial policy of growing or “inflating” out of the debt in light of Congress’ unwillingness to tackle budget deficits running at more than $1 trillion for the foreseeable future.

They point to the example set after World War II, the only other time the U.S. accumulated a massive public debt totaling more than 100 percent of yearly economic output, the figure it is projected to reach in the next decade.

The country never really paid off the war debt. Rather, it was able to reduce the debt burden within a couple of decades to a minimal 30 percent of economic output through a combination of robust growth after the war and moderate inflation rates of between 4 percent and 6 percent. By printing more dollars and slowly diminishing their value over several years, the U.S. was able to pay back its debts more easily.

Spyros Andreopoulos, international budget analyst at Morgan Stanley, said investors and citizens who look at Greece’s debt plight and fear the U.S. government may one day face a similar crisis in which it is in danger of default are missing the point.

“A hard default is inconceivable” for the United States, with its huge debts and leading economic role in the world, he said. But “soft default through inflation is a clear risk.”

Mr. Andreopoulos calculates that it would take post-World War II levels of inflation or higher today to keep public debt at the still-high but manageable level of about 60 percent of economic output, where it is today.

“Inflation was the largest factor behind debt reduction” after World War II, he said. “Growth was the second-largest factor,” with Congress making only a small contribution through modest budget restraint. The behind-the-scenes role of the Federal Reserve in accommodating faster growth and inflation through faster money creation was critical, he added.

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