Armstrong: Only inflation will combat Western debt

Inflation is the only way to reduce the high debt to GDP forecast for the UK and US, which is set to match that of Greece by 2014, says Distinction Asset Management’s Ana Armstrong.

The former Insight multi-manager says according to IMF estimates, debt to GDP is expected to be around 100% for the UK and US by 2014.

She says there are historically three main solutions for recovering the high debt levels, although inflation looks to be the "only way" out of the problem.

One option is sustained growth, although she says this is not a likely scenario. "Growth is anaemic in the West, unemployment is quite high at 10% in the US, and with GDP depending heavily on consumption, growth cannot materialise like it did five years ago.

"So in the West, I do not think growth will pay off debt - that is clear."

She says the second option is a default, although it is unlikely governments will opt for this. "Even Greece will not default, let alone countries like the UK and US."

Consequently, Armstrong says: "Inflation is the only way of getting out of the debt issue."

Inflation will devalue the debt and could serve as a solution for US policy makers, she argues. "In the US, almost 40% of their debt is held by foreigners - if you look at US treasuries, China and Japan hold almost 44%.

"So the whole idea of inflation, the plummeting dollar and seeing the wealth transfer to the US economy, means inflation can actually work out well. There is incentive to create inflation, although this is not a great long-term solution."

She adds the UK is in a similar debt situation, but is already implementing measures, whereas the US is "more relaxed."

"The US will be hit even harder with the problem - they have the whole election story, nobody wants to be drastic in imposing higher taxes."