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  • Is hyperinflation possible?

    Is Hyperinflation Possible?

    We have since 1999 believed that the US was destined to inflate its way out of excessive debt, both public and private. The logic of our conclusion is simple. The government can never pay off its debts to foreign governments or to itself – not enough national income. US households can't pay their debts either for lack of opportunities to increase income to cover debts. The Fed has the option to inflate in any economic or financial system crisis that might precipitate a debt crisis because the US is not on a gold standard as it was in the early 1930s when the US suffered a monetary deflation as a result of the last debt crisis. And, finally, monetary inflation is politically expedient because it cannot be readily blamed on one political party, arising as it does from the bipartisan Fed, whereas taxes – the honest means for paying public debts – is political death for the party that chooses it.

    In any case, increasing taxes during the kind of economic contraction that typically leads to debt crisis is, as economists say, counter cyclical, like asking your wife if it's okay if you go play cards and drink beer with your friends right after you've finished apologizing for forgetting her birthday, again.

    Our expectation was for an inflation to culminate in a 100% rise over a period of five or six years, a major inflation such as occurred in Mexico and Russia in the 1990s, but not hyperinflation as occurred in the Wiemar Republic in the 1920s or Zimbabwe today. We recently read a report by a credible source that makes an extensive case for an American hyperinflation.

    When we read John William's recent report on hyperinflation Hyperinflation Special Report it struck us as extreme. He suggests a scenario that, unlike ours, says the Fed has no choice but to cause a hyperinflation in order to avert a collapse of the financial system.

    To re-calibrate ourselves to analyze William's report we returned to the St. Louis Fed's web site to see how the charts are doing that we first reviewed in January 2008 that show how much the Federal Reserve System member banks, and we suppose now investment and other banks that are not officially part of the Federal Reserve system, are borrowing from the system as the financial crisis that started in June last year continues. Keep in mind that a few "the worst is over" articles came out last week from Sir Warren Buffett and Hank Paulson. Here's what we found.


    This chart shows how much money was left in the Federal Reserve Banking System
    reserve accounts in aggregate across the Federal Reserve system when member banks
    drained funds from reserve accounts during previous crises versus this one.

    The little blip you see around the time of 911 is the Greenspan Fed expanding reserves in a bid to prevent exactly the kind of event that is happening now. He was afraid that a panic would set off a rush for cash and he wanted to make sure the banks had enough.


    This chart shows how much money was borrowed from Federal Reserve Banking System
    reserve accounts in aggregate when member banks drained reserves from the
    Fed system during previous crises versus this one.

    We are in the midst of a financial crisis completely without precedent. An analysis by economist John Atlee at Harvard in 2001 shows, "...bank reserve balances at the Fed -- the only reserves the Fed actually controls by its open market operations -- are now only about $7 billion. That's a miniscule 1.3% of checking accounts (not the official 10%), resulting in... extreme leverages." At the time he wrote that report in 2001, total borrowings had never in the Fed's entire history exceed a few billion in a crisis. Atlee, by the way, is in favor of a 100% reserve requirement.

    What does it mean? Again, as this circumstance is unprecedented no one knows, but John Williams' hyperinflation scenario is no longer out of the question. Why? Because the only obvious way out is to monetize debt far in excess of reserves that the Fed controls via open market operations. Once printed the Fed has no control over where the money thus created goes, and thus it goes into everything. Oil prices rise. Food prices rise. Stock prices rise. Purchasing power declines.

    When we showed these charts previously, when the crisis first started, we received nasty emails from readers who were convinced we'd made these scary charts ourselves and distorted the data to create a dramatic appearance. They are freely available at the St. Louis Fed's web site here and here.

    The official iTulip position on hyperinflation:
    Warning about a dollar hyperinflation makes good theater but has little value from an investment perspective. As we've pointed out many times and most recently here in How to make $301% in six years with low volatility, dollar hyperinflation is not in the cards.

    For a nation to experience a hyperinflation, all four of the following conditions need to be met:
    1. Large and growing external debt as a percentage of GDP with falling GDP (Yes, like the US.)
    2. Politically and economically isolated and irrelevant (Not like the US. Think: Zimbabwe.)
    3. No external demand for the currency (Not like the US dollar. Think: Iraqi Dinar.)
    4. Political chaos (i.e., tanks rolling down the street, not like the US.)
    The US meets only the first condition. The US is certainly more politically isolated than in the past but as the world's largest economy is hardly irrelevant. The dollar is still a reserve currency so hardly meets the third criteria. The US is arguably one of the most politically stable on earth so the 4th condition is out.

    Hardly the stuff of hyperinflation. That said, the value of a common share of USA, Inc.–the US dollar–will continue to come under pressure.
    As for the charts above, some say that the sudden surge in reserve borrowing is a technical anomaly, due to a change in the way the Fed accounts for new more creative forms of discount window borrowing. That's true except that the Fed should have taken steps to avoid the distortion the added lending created to the long term borrowed reserves data set and instead created a new one, and at some point the Fed runs out of ways to lend without expanding its balance sheet. Then the William's scenario starts to look possible, but not before a lot of other events occur first.

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    Last edited by FRED; 05-10-08, 09:16 PM.
    Ed.

  • #2
    Re: Is hyperinflation possible?

    Caroline Baum in Bloomberg (I think this one was posted here) says you're a tinfoil hat wearer if you worry about non-borrowed reserves. She says it's all about the TAF.

    The WSJ with a similar explanation (re: TAF) "What, me worry?"
    Last edited by Slimprofits; 05-10-08, 07:30 PM. Reason: no need to post excerpts, the links are still good

    Comment


    • #3
      Re: Is hyperinflation possible?

      williams' scenario is based on the idea that the u.s. dollar becomes repulsive enough that only the fed will buy the debt produced by the deficit-laden medicare and social security paying u.s. gov't. i still wonder if the fed can make the dollar more attractive by RAISING short term rates while conducting open-market purchases of long-dated paper. [long-rates would have presumably risen sharply prior to reaching the point at which this intervention was implemented.]

      the higher short-term rates would undercut dollar-based carry trades which depend on short-term borrowings and thus create a technically based flow towards the dollar which would reinforce any hot money return-seeking flows. a few points at the low duration end would suffice to make dollar returns internationally competitive.

      meanwhile purchases at the long end would cause a short-covering bond rally, and make long bonds look attractive to trend followers.

      bernanke explicitly discussed buying long bonds in his "keeping 'it' from happening here" paper.

      would such an intervention pattern moderate the underlying inflationary trend enough to produce merely high inflation, instead of hyperinflation? the more i think about this scenario, the more plausible it seems to me. holes in my thinking here?

      Comment


      • #4
        Re: Is hyperinflation possible?

        Originally posted by jk View Post
        williams' scenario is based on the idea that the u.s. dollar becomes repulsive enough that only the fed will buy the debt produced by the deficit-laden medicare and social security paying u.s. gov't. i still wonder if the fed can make the dollar more attractive by RAISING short term rates while conducting open-market purchases of long-dated paper. [long-rates would have presumably risen sharply prior to reaching the point at which this intervention was implemented.]

        the higher short-term rates would undercut dollar-based carry trades which depend on short-term borrowings and thus create a technically based flow towards the dollar which would reinforce any hot money return-seeking flows. a few points at the low duration end would suffice to make dollar returns internationally competitive.

        meanwhile purchases at the long end would cause a short-covering bond rally, and make long bonds look attractive to trend followers.

        bernanke explicitly discussed buying long bonds in his "keeping 'it' from happening here" paper.

        would such an intervention pattern moderate the underlying inflationary trend enough to produce merely high inflation, instead of hyperinflation? the more i think about this scenario, the more plausible it seems to me. holes in my thinking here?
        have to dig around but somewhere on this forum is a more detailed explanation of why itulip thinks a runaway hyperinflation can't happen... as i recall it's along the lines of what you're saying here... one of the conditions is a total repudiation of the currency by foreign lenders. the hyperinflating country is literally on its own. one way the usa avoids that is to sell bonds but at a lower price, as you say. keeps demand for dollars up. but... as someone pointed out elsewhere you posted this that spells bad news for the economy and that's dollar negative, too. that's the trap that argentina et al fell into, or rather, were shoved into by the imf. looks like the ol' usa has set this trap for itself. that's the "poom" cycle as i understand it.

        Comment


        • #5
          Re: Is hyperinflation possible?

          Originally posted by babbittd View Post
          Caroline Baum in Bloomberg (I think this one was posted here) says you're a tinfoil hat wearer if you worry about non-borrowed reserves. She says it's all about the TAF.

          The WSJ with a similar explanation (re: TAF) "What, me worry?"
          I'm not sure, but I think Bart has weighed in on this question previously as well.

          And, if memory serves, Caroline Baum is actually someone EJ and/or the Freds have credited with being very savvy in the past.

          Comment


          • #6
            Re: Is hyperinflation possible?

            Originally posted by metalman View Post
            have to dig around but somewhere on this forum is a more detailed explanation of why itulip thinks a runaway hyperinflation can't happen... as i recall it's along the lines of what you're saying here... one of the conditions is a total repudiation of the currency by foreign lenders. the hyperinflating country is literally on its own. one way the usa avoids that is to sell bonds but at a lower price, as you say. keeps demand for dollars up. but... as someone pointed out elsewhere you posted this that spells bad news for the economy and that's dollar negative, too.
            long bond prices go lower [rates go up] at some point, but then bonds bounce when the fed starts buying them, capping the move. that's my theory, anyway. the fed can just say that they'll buy any t-bonds of over 10 years duration which pay more than x% this kind of intervention, in fact, is explicitly described in the bernanke paper i keep referencing. this would trigger the mother of all short covering rallies in the bond market. simultaneously raise the fed funds rate and you've got both long- and short-term money heading for the u.s., supporting the dollar even as the fed injects money via its bond purchases.

            edit- the fed can't do this until wages have inflated enough to allow consumers to carry their debt burden. but wage push will not be a major contributor to inflation; it will lag. this inflation stems from dollar weakness and will be capped by interventions aimed at stemming dollar weakness, not aimed at reducing demand. demand for non-necessities will already have been crowded out by food and fuel inflation.
            Last edited by jk; 05-10-08, 09:01 PM.

            Comment


            • #7
              Re: Is hyperinflation possible?

              Originally posted by jk View Post
              long bond prices go lower [rates go up] at some point, but then bonds bounce when the fed starts buying them, capping the move. that's my theory, anyway. the fed can just say that they'll buy any t-bonds of over 10 years duration which pay more than x% this kind of intervention, in fact, is explicitly described in the bernanke paper i keep referencing. this would trigger the mother of all short covering rallies in the bond market. simultaneously raise the fed funds rate and you've got both long- and short-term money heading for the u.s., supporting the dollar even as the fed injects money via its bond purchases.

              edit- the fed can't do this until wages have inflated enough to allow consumers to carry their debt burden. but wage push will not be a major contributor to inflation; it will lag. this inflation stems from dollar weakness and will be capped by interventions aimed at stemming dollar weakness, not aimed at reducing demand. demand for non-necessities will already have been crowded out by food and fuel inflation.
              jk - Through what device will wages inflate on a nominal basis? I don't see how this will happen in the US. Wage earners have almost no power to drive their earnings above inflation and surely no benevolent employer group is going to shine the pre-1980 light of wage growth on US employees.

              What movement will drive wage inflation? Most people have debt profiles that keep them from sleeping well at night much less joining a movement that will result in real wage gains.

              Comment


              • #8
                Re: Is hyperinflation possible?

                Originally posted by jk View Post

                demand for non-necessities will already have been crowded out by food and fuel inflation.
                I think this is correct. Went to my favorite high-end audio action site (www.audiogon.com) and the deals just keep getting better and better. Most people cite "change of plans". I'm thinking change in the economy.

                Being liquid right now is good, till the equation changes. Of course "Hard" liquidity would seem to be the best source of liquidity in this environment.

                I think that the disconnect between used goods for sale and raw material/energy and food prices is most interesting. On the one hand cash is king, on the other, cash is trash. Anyone else noticing this? Anyone care to comment on what they think this means?

                Comment


                • #9
                  Re: Is hyperinflation possible?

                  “If I rob a bank, they throw me in jail. But if they rob me, then they say that's OK”, screamed a protester who had joined thousands of others outside the office of Argentina's President Eduardo Duhalde on January 11 to demand protection from the country's tumbling economy.

                  The protester was pointing to the institutionalized theft that the Argentinian people have been subjected to for decades. The beneficiaries are Argentina's big corporations and ruling class, as well as the top corporations and governments of the richest countries.

                  We might get more of a controlled hyperinflation like Argentina rather than a Weimar case like John Williams is looking for. Williams rightfully points out all the reasons why some type of hyperinflation will take place.

                  As Michael Hudson points out, the U.S. WANTS a disorderly collapse in the dollar. The Euro bottomed at .86 and has almost doubled to 1.60. That's fine and dandy but at some point TPTB know this will turn into a runaway collapse and then the "real" value of debt will be depreciated by 5 or 10. No policy has been put in place at the gov't or FED level so they are implicitly condoning this event. James Turk says he thinks it might happen this summer.

                  Maybe the hyperinflation in the Soviet Union in 1992 would be another good model for what ours might look like.

                  Comment


                  • #10
                    Re: Is hyperinflation possible?

                    Originally posted by santafe2 View Post
                    jk - Through what device will wages inflate on a nominal basis? I don't see how this will happen in the US. Wage earners have almost no power to drive their earnings above inflation and surely no benevolent employer group is going to shine the pre-1980 light of wage growth on US employees.

                    What movement will drive wage inflation? Most people have debt profiles that keep them from sleeping well at night much less joining a movement that will result in real wage gains.
                    wages tend to rise over time. i know that my back office and secreatarial employees expect, and get, small raises on an annual basis. [perhaps 2.5-4%] minimum wage legislation will likely be passed by a democratic legislature. if people stop spending more than they earn, and - imagine - start to pay down debt a bit, this adds up. as i said, i think wages will lag overall inflation; people will be falling behind on the cost of necessities. but as long as they don't add to their debt, they gradually improve their position. also some of the debt will be liquidated by default. so overall, the ratio of income to debt will improve.

                    Originally posted by jtabeb
                    Went to my favorite high-end audio action site (www.audiogon.com) and the deals just keep getting better and better. Most people cite "change of plans". I'm thinking change in the economy.

                    Being liquid right now is good, till the equation changes. Of course "Hard" liquidity would seem to be the best source of liquidity in this environment.

                    I think that the disconnect between used goods for sale and raw material/energy and food prices is most interesting. On the one hand cash is king, on the other, cash is trash. Anyone else noticing this? Anyone care to comment on what they think this means?
                    the real cost of necessities is going up with increased global demand. the real cost of toys is going down with increased global production. it turns out that it's easier to ramp up the production of toys than to ramp up the production of necessities.

                    Comment


                    • #11
                      Re: Is hyperinflation possible?

                      Originally posted by jk View Post
                      wages tend to rise over time. i know that my back office and secreatarial employees expect, and get, small raises on an annual basis. [perhaps 2.5-4%] minimum wage legislation will likely be passed by a democratic legislature. if people stop spending more than they earn, and - imagine - start to pay down debt a bit, this adds up. as i said, i think wages will lag overall inflation; people will be falling behind on the cost of necessities. but as long as they don't add to their debt, they gradually improve their position. also some of the debt will be liquidated by default. so overall, the ratio of income to debt will improve.


                      the real cost of necessities is going up with increased global demand. the real cost of toys is going down with increased global production. it turns out that it's easier to ramp up the production of toys than to ramp up the production of necessities.
                      The question of wage inflation needs to include the political question of "whose wage inflation?"

                      I address that in Dual Cycles of Demand Destruction and the Economic Face Plant.

                      The relevant chart is this one:

                      To santafe's point, the lower 90th percentile wage earners have not been able to increase wage rates. Historically, in time order, policies designed to reduce wage pricing power were 1) elimination of unions during the early 1980s recessions, 2) immigration policy, and 3) outsourcing along with the policies that resulted in increased overall indebtedness...



                      The impact of the inflation tax falls most heavily on the 90th percentile.



                      In my opinion, inflation was the primary cause of the current recession, as the chart above suggests, in combination with the loss of access to HELOC credit and negative wealth effects of the collapsing housing bubble. This brings us back to the dual cycles of demand destruction.



                      As we discussed in the interview with Steve Keen, wage inflation can be achieved by reversing the policies which have prevented it: 1) strengthening of unions and other wage power collectives, 2) tightening immigration policy, and 3) restricting outsourcing via labor condition equalization provisions. As for a decrease in overall indebtedness that lowers the debt liabilities of wage earners and gives them greater capacity to bargain for higher wages, that is a more complex question that we will have to address later.

                      This is why we have for years suggested that if you want to see a proxy for future inflation, watch the rise in the size and power of unions and other wage power collectives, immigration and outsourcing policy.

                      Comment


                      • #12
                        Re: Is hyperinflation possible?

                        I am long term bullish on precious metals, especially Silver coins.

                        I am of the opinion that for the next year or so that Stagflation will rule.

                        I predicted a year ago the Crisis in the Summer of 2008. And I foresee a modest rebound now through Xmas because of the stimulus checks and the cuts of the Fed funds rate.

                        I predict another crisis which I shall call The Crisis in the Fall of 2009.

                        The Crisis in the Fall of 2009 will be followed in 2010 by a low in housing prices and thus the end of Stagflation. What will follow will be inflation, very rapid inflation with rising interest rates. I have a wild ass guess that Silver will spike, go parabolic to $200. God only knows how high Gold will go.

                        I premise this wild inflation on Bart's M3 growth and an expectation that the Democrats will control the government. Another reason is that the Fed has booked half a Trillion in very low quaility securities onto its balance sheet. These dogs will have failed in undeniable defaults and the Fed will monitize them. The Democrats will promote and pass a massive bailout for The Crisis in the Fall of 2009.

                        By the Mayan calendar and prediction, 2012 will be the end of the world as we know it. The US will economically implode in the aftermath of fighting the very rapid inflation that will have started in 2010.

                        2012, the end of the world as we know it

                        Comment


                        • #13
                          Re: Is hyperinflation possible?

                          JK,

                          Admittedly the US as the progenitor of its own currency, the dollar, has the option of buying back its own dollar debts.

                          The Fed can be the vehicle to play games with the financial markets.

                          But ultimately all purchasing must be backed by some type of productivity.

                          Why would anyone else in the world want to buy a US dollar security when the US government is itself creating money to prop up the prices of said securities?

                          Sure, if everyone else goes along with the fiction that dollars (credit or actual) are not being printed like mad, then it might work.

                          But why would they?

                          As for the question of military intervention - the collapse of the Soviet Union is a prime example.

                          Russia had all sorts of sovereignty: lots of nukes, lots of people, its own currency, etc.

                          Russia could easily have defaulted on all its external and internal debts, but did not because doing so would have resulted in widespread hunger in the population.

                          The US probably doesn't have the hunger factor, but I think people stranded in their suburban homes without jobs or gas would be equally bad.

                          Comment


                          • #14
                            Re: Is hyperinflation possible?

                            EJ, you acknowledged the plausibility of Williams' hyperinflation scenario...

                            Originally posted by FRED View Post
                            [John Williams] suggests a scenario that, unlike ours, says the Fed has no choice but to cause a hyperinflation in order to avert a collapse of the financial system.
                            ...and then juxtaposed it against the iTulip scenario of likely major -- but not hyper -- inflation. You restated the logic that you had set out earlier, listing four conditions that are required for the hyperinflation scenario:

                            Originally posted by FRED View Post
                            For a nation to experience a hyperinflation, all four of the following conditions need to be met:
                            1. Large and growing external debt as a percentage of GDP with falling GDP (Yes, like the US.)
                            2. Politically and economically isolated and irrelevant (Not like the US. Think: Zimbabwe.)
                            3. No external demand for the currency (Not like the US dollar. Think: Iraqi Dinar.)
                            4. Political chaos (i.e., tanks rolling down the street, not like the US.)
                            The US meets only the first condition. The US is certainly more politically isolated than in the past but as the world's largest economy is hardly irrelevant. The dollar is still a reserve currency so hardly meets the third criteria. The US is arguably one of the most politically stable on earth so the 4th condition is out.
                            Rejection of the Williams hyperinflation scenario apparently rests on the conclusion that it is highly improbable that the US will meet the four posited conditions.



                            Inflation 1923-24: A German woman feeding a stove with currency notes, which burn longer than the amount of firewood they can buy.
                            [The image and caption above are from the Wikipedia article on hyperinflation.]

                            Wikipedia offers two closely related models of hyperinflation: (1) the crisis of confidence (people begin to doubt that the issuing authority will remain solvent) model and (2) the monetary model (rapid increase in amount of cash in circulation). Neither of these models, however, stipulates any of the four conditions, although some are related.

                            How essential are these four conditions?

                            Comment


                            • #15
                              Baum, Kasriel - Borrowed Reserves

                              Let's see if I got this right.

                              Baum and Kasriel (whom she quotes, below) are saying it's a definitional thing of no real importance.

                              Reserves can be obtained three ways today:

                              - Open Market Operations ("non-borrowed")
                              - Discount Window ("Borrowed")
                              - TAF ("Borrowed")


                              "The minimum bid the Fed accepts [at the TAF} is the expected funds rate one month out, which in the current environment means cheaper funding costs than the fed funds market."

                              Now, why all the fuss? asks Kasriel - there is a cheap deal on at the TAF and that's why the banks are going there rather than the non-borrowed route:

                              "``Suppose the Fed cut the discount rate so that it stood below the funds rate,'' Kasriel said. (He said this yesterday, not two decades ago.) ``Would these folks be upset if banks went to the discount window for funds? What's the difference? It's a difference without a distinction.''"

                              Hmmm. But surely, folks WOULD be upset if the amount money currently borrowed from the TAF were instead borrowed via the Discount Window, at a rate below Fed Funds. Borrowing the majority of reserves more cheaply than buying them at the Feds Fund rate - that's a bit odd isn't?

                              Wikipedia on the Discount Window:
                              "In recent years the discount rate has been approximately a percentage point above the federal funds rate (see Lombard credit). Because of this, it is a relatively unimportant factor in the control of the money supply, and is only taken advantage of at large volume during emergencies."

                              "during emergencies". Hmmm.

                              Note also that through the last crisis the Discount rate has remained above the Fed Funds rate.

                              Doesn't this mean that instead of an unseemly emergency rush to the discount window, the banks have been sent around the back of the building where the borrowing is large and perhaps a bit easier - 28 days and distressed collateral.

                              One last thing:

                              "The minimum bid the Fed accepts [at the TAF} is the expected funds rate one month out, which in the current environment means cheaper funding costs than the fed funds market."

                              What happens when the futures market prices in rising interest rates?

                              Doesn't this mean that the Fed can't raise rates if they wish to keep the TAF in operation? Although I suppose it could still work for people who can't ante up any Treasuries and can only supply MBS et al.

                              Comment

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