If you owe someone money, you have two options:
1. Pay the loan back. Work to earn money or spend less, and pay them back.
2. Default on the loan. Say, “Hey, I know I’m an awful person for this, but I can’t pay you back, and I won’t ever be able to.”
If a government owes someone money, it has these same two options, but also a third. It can print the money it owes and give it back that way.
This third option, though, dilutes the value of the cash for everyone who holds cash. This is inflation - the inflation of the money supply. Let me explain as simply as possible.
Let’s make it easy and say there are 10 people in the world, and all 10 have $100 each. In this world, there is $1,000 in total circulation (10 people with $100 each = $1,000). Let’s also say in this world Lamborghinis are $100 each, and there are only 10 of them. So, all 10 people can buy one Lamborghini each if they want one. In other words, one Lamborghini equals 10% of the entire cash in this world, and each person has 10% of the entire cash in this world.
Let’s say Person 1 is the government, and Person 2 loans the government their $100. But instead of cutting spending (Option 1) or explicitly defaulting (Option 2), they invoke the third option and print out an extra $100 to pay it back to Person 2. Now, there is $1,100 in this fake world. Given that Lamborghinis are 10% of the entire cash supply in this world, a Lamborghini is now $110 (10% of $1,100). Instead of everyone having enough cash to buy a Lamborghini, now only Person 1 can afford a Lamborghini, and no one else can.
With the push of a button, Person 1 made it impossible for everyone else in this world to buy a Lamborghini except themselves - and they kept the cash they were morally obliged to pay back.
Now do you get how inflation works?
