Morgan Stanley: Foreign U.S. Debtholders Fuel Inflation

Tuesday, 13 Apr 2010 08:19 AM

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Morgan Stanley analyst Spyros Andreopoulos says the fact that more than 50 percent of U.S. debt is held by foreign countries makes inflation much more likely.

"The ownership of debt determines who will be affected by higher inflation, his report reads.

"The higher the foreign ownership, the less will the fall in the real value of government debt affect domestic residents."

Unlike domestic owners, foreign owners may not necessarily be interested in the real value of government debt since they consume goods in their own country, Andreopoulos notes.

However, they will nonetheless be affected by the inflation-induced depreciation, thus increasing the temptation to inflate with the share of foreign ownership of the debt.

“We have argued for some time now that there are substantial upside risks to the medium-term inflation trajectory globally,” Andreopoulos writes. “One of the main reasons — but not the only one — is the dire fiscal outlook in developed economies.”

He points out that central banks “may generate, allow or acquiesce to higher inflation” in order to help over-levered public and private sectors with their debt burdens.

In other words: Debtflation.

“A rational, forward-looking central bank may decide to generate or live with a controlled amount of higher inflation now, rather than find itself in a more difficult position a few years down the line because of unsustainable debt evolutions,” Andreopoulos says.

The Economic Cycle Research Institute’s monthly measure of U.S. inflation pressures rose to an 18-month high in March, Reuters reports.

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