Inflation Induced Debt Destruction

What is debt?

Debt is an act of borrowing something from someone else, with an obligation to repay over time, something which you don't have ownership. It has two parties own who gives and one who receives. You repay the debt overtime in small investments.

Inflation and time value of money.

The prices of all goods and services increases gradually over the time due to inflation. And money loses its value.

The purchasing power of money is much higher today than tomorrow or in coming years. The value of money you return is less in terms of purchasing power of money due to inflation.

Just understand this simple example here

• You have 1000 rupees now. With this much money you can purchase 10 gram of silver. Or 10 cup of coffee in Starbucks.

• Assume You are paying 1000 rupees as loan repayment after 1 year.

Due to inflation of 10%, next year, the value of commodity appreciates by 10%. Now the price of silver for 10 grams is 1100. For the same 1000 rupees you cannot buy 10 grams of silver, you can buy only 9 grams of silver. Or 9 cup of coffee in Starbucks. The purchasing power has reduced. In the same way your debt value also has decreased. You will still pay only 1000. your loan value has not increased by 10%.

Imagine what will happen if deflation happens. The value of all commodities goes down. Assuming the same 10% deflation, after one year the 1000 rupees you had earlier will now fetch you 11 grams of more silver and 11 cup of Starbucks coffee. This means that your purchasing power has increased.

Now imagine in this scenario, when purchasing power has increased, where you can enjoy once cup of more coffee for 1000 rupees, you are repaying debt of 1000. when the opportunity is good enough to buy assets if you are repaying debt means you are paying more. It means you are giving 11 grams of silver to repay the debt.

When there was inflation, you are paying only 9 grams of silver to repay the debt. During deflation you are paying 11 grams of silver to repay the debt. This is how inflation destroys debt. So, it is better to buy assets today than tomorrow with debt or loan. The value of money you repay is less in terms of purchasing power. But value of assets keeps increasing. If that assets can produce cashflow then return on investment is much higher.

when purchasing power is high you should buy assets do not repay debt.

Key Insight

• Inflation Benefits Borrowers: Debt becomes easier to repay as the value of money declines, while assets purchased with borrowed funds often appreciate in value.

• Deflation Hurts Borrowers: Debt repayment becomes more expensive in real terms because money gains value.

Conclusion

Debt, when used to acquire appreciating or income-generating assets, can be highly advantageous during inflation, as the real cost of repayment decreases over time. However, during deflation, the real cost of debt rises, making repayment more burdensome. Understanding this relationship helps borrowers make smarter financial decisions.