Debt, Inflation, Exchange Rate |
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As noted above, debt is normally denominated in a particular monetary currency, and so changes in the valuation of that currency can change the effective size of the debt. This can happen due to inflation or deflation, so it can happen even though the borrower and the lender are using the same currency. Thus it is important to agree on standards of deferred payment in advance, so that a degree of fluctuation will also be agreed as acceptable. It is for instance common to agree to "US dollar denominated" debt.
The form of debt involved in banking gives rise to a large proportion of the money in most industrialised nations (see money and credit money for a discussion of this). There is therefore a complex relationship between inflation, deflation, the money supply, and debt. The store of value represented by the entire economy of the industrialized nation itself, and the state's ability to levy tax on it, acts to the foreign holder of debt as a guarantee of repayment, since industrial goods are in high demand in many places worldwide.
Inflation indexed debt
Borrowing and repayment arrangements linked to inflation indexed units of account are possible and are used in some countries. For example, the US government issues two types of inflation indexed bond - TIPS and I-bonds. These are one of the safest forms of investment available, since the only major source of risk - that of inflation - is eliminated. A number of other governments issue similar bonds, and some did so for many years before the US government.
In countries with consistently high inflation, ordinary borrowings at banks may be inflation indexed also.
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