Hyper-Inflation or Just Hype?

There has been a lot of talk lately about the risk of hyperinflation (meaning extremely rapid or out of control inflation). Once the domain of economists and financial geeks, the concept has reached into the popular culture. Recently, Peter Schiff made an appearance on "The Daily Show", and drew cheers from the audience when he reiterated his prediction that the US economy would collapse due to hyperinflation.

When economic ideas become popularized, they tend to succumb to hype. It's hard to make predictions, especially about the future (as Yogi Berra noted), but that's what markets try to do. How much is the market responding to this threat?

Investors have three traditional ways to hedge against inflation: precious metals, real estate, and TIPs. If concern about our currency is becoming as widespread as the buzz suggests, we should see demand for these assets increasing.

Precious metals, typified by gold, increased in value up until 2008, peaking slightly over $1000/oz.

To date, it has not exceeded that value. I know many investors are convinced that it will; all I can say is "show me the money."

But I admit that the ambivalent price of gold, in itself, is not proof that investors are ambivalent about future value of the dollar. Gold is a global resource; increased demand by US investors might be offset by weaker demand, or sales, elsewhere.

So... let's try closer to home, with TIPS (Treasury Inflation-Protected Securities). Analysts measure the market's "expectation of inflation" by the spread between yields on fixed-rate Treasuries and TIPS; the difference should express the expected inflation rate (since this value is added to the TIP).

Maturity	Fixed yield	TIP yield	Implied inflation rate
2014	2.83	1.41	1.42
2019	3.79	1.88	1.91

By this metric, the market is expecting below-average inflation over the next 10 years (and especially low in the next 5 years).

Here's another way to view the same relationship, by way of ETFs instead of individual bonds:

Here we see that investors have priced TIP and TLT (a long Treasury bond fund) at a near-constant ratio for 5 years, except for the panic last fall, when TLT became much more highly valued, due to the fear of deflation. The ratio has just begun to return to its long-term norm. Fear of inflation would drive it far above this line. Instead, we are in neutral. For every investor expecting inflation, there's at least one other one worrying about deflation.

Although this is a cleaner way to measure inflation than gold, it's not perfect. Some investors don't like TIPS because their value depends on the government's calculation of inflation, the CPI. So this indicator, too, is only suggestive of the larger question. Let's look at the last resort of the inflation-hedger, real estate.

At last, we have data which is unambiguous. Commercial RE values are plunging at an unprecedented rate.

This is a real threat to our financial system, as many other commentators have noted. The threat, however, is not inflation, but its opposite: deflation.

That makes three strikes for the hyperinflation indicators.

I'm not suggesting that any of these asset classes are useless; on the contrary, a well-balanced portfolio should include all kinds of hedges. But if you go all-out for the inflation hedge, you are years ahead of the market. That kind of position rarely pays.

Disclosure: the author maintains a small position in TIP.

Comments

[long roh:]

This article was fairly useless. I don't need the weather report to tell me that it's sunny outside right now. Similarly, I don't find it useful to read that we haven't yet begun inflation in earnest -- it tells me nothing about whether there is a hyperinflationary storm ahead.

U.S. institutions and individuals have been too busy repairing balance sheets to worry about hoarding hard assets or other currencies. (Non-U.S. institutions are worried about that already.) What's more interesting is whether other fiat currencies collapse along with the dollar or if the issue is just contained to the U.S. (i.e. a shift away from the dollar as reserve currency). I tend to think that we will not lose reserve status unless it becomes clear to the rest of the world that our gov't is never going to raise taxes or end entitlement programs in order to pay down the debt. Once default becomes a serious part of the endgame for the mountain of U.S. debt, there will be a breathtaking rush to the exits.

Jun 15 01:50 PM

[schmaboo:]

The reason why these three indicators are not yet flagging red was
given by Rees-Mogg and Davidson 20 years ago: Inflation comes
roaring back when people least expect it.

Jun 15 02:25 PM

[Birdsnest:]

For inflation to persist wage increases have to manifest or the price increases just won’t “stick”. People will simply not pay the higher price (other than for primary foodstuffs and heat – and even then people can cut back to subsistence levels). Any persistent price increase and primary demand will plummet due to stagnant nominal wages. Significant wage increases can only occur when employers are forced to pay due to shortages of labor or particular skill sets. At 10%+ unemployment no one has any bargaining power for wage increases. Your employer (any private sector employer that is) can go out tomorrow and replace you with someone cheaper. Who has any form of job security today? They retain you merely because it would be disruptive to replace you. No one is indispensable. It will take a decade of consistent job growth to simply drive down the unemployment rate to anything approaching full employment. Employers all around me are cutting hours or nominal wage rates. 401K matches are being eliminated. People are trying to rebuild their balance sheets. They will be buying only needs and not wants. Other than necessities you have to convince them to buy. As for necessities, people continue to trade down. I only see deflation or flat prices in this environment for years to come.

Jun 15 02:25 PM

[4rdvark:]

That gold graph looks like it's going in the "up" direction.

Jun 15 03:32 PM

[robert.b.fe...:]

The Fed has been buying Tresuries for months thereby monetizing debt. I'm not the sharpest tool in the shed but financing debt with more debt seems like a bad idea. Speaking of inflation gassoline went up $.17 last week. A 32OZ jar of Hellmans Mayonais went for $2.96 last year at this time. They are over $6 now. Call it what you want but inflation seems to be a good name to me.


On Jun 15 11:31 AM MGA_1 wrote:

> There will be a tremendous amount of deflationary pressure for the
> next couple years due to housing and commercial real estate loan
> defaults. 2008 saw quite a bit of deflation, *except* for govt intervention.
>
>
> If we were to have inflation, then potentially hyperinflation, it
> would be purely through govt monetary policy. Bernanke has been injecting
> a tremendous amount of money into the economy and seems very intent
> on preventing that great evil... deflation.
>
> The thing to really watch for will be govt purchase of treasury bills.
> I think they will be forced to simply because of the amount of debt
> about to come on the open market which should spike interest rates
> thereby stifling any recovery.
>
> Direct purchase of t bills by the fed is inflationary. I actually
> expect them to do this through the upcoming year and also expect
> commodity prices to climb.
>
> If the fed ever has to directly monetize the interest on the debt,
> then it's game over and we will DEFINITELY have hyperinflation.<br/...
>
> How to prevent all of this? Balanced budgets and a gold backed dollar
> !

Jun 15 04:10 PM

[robert.b.fe...:]

Almost forgot that those unskilled/entry level people who still have jobs will be getting a raise when minnimum wage goes up. Thank you Nancy.

Jun 15 04:13 PM

[dw57:]

but wasn't carter i don't know about 19 YEARS LATER?
and wasn't going back to the gold standard part of England's problem right before the GD hit?


On Jun 15 01:22 PM Missing_Link wrote:

> On Jun 15 12:09 PM Angel Martin wrote:

Jun 15 04:22 PM

[dw57:]

but will the private sector pay its debt? its far larger than public debt. and that is probably giving every country night mares.

but without the private debt reduction, the consumer won't buy their products.
consider Germany one of the most conservative fiscally, but also one of the most impacted by consumer demand collapse.
or China, without their small stimulus they would have had an even worse impact from consumer demand collapse


On Jun 15 01:50 PM long roh wrote:

> This article was fairly useless. I don't need the weather report
> to tell me that it's sunny outside right now. Similarly, I don't
> find it useful to read that we haven't yet begun inflation in earnest
> -- it tells me nothing about whether there is a hyperinflationary
> storm ahead.
>
> U.S. institutions and individuals have been too busy repairing balance
> sheets to worry about hoarding hard assets or other currencies.
> (Non-U.S. institutions are worried about that already.) What's more
> interesting is whether other fiat currencies collapse along with
> the dollar or if the issue is just contained to the U.S. (i.e. a
> shift away from the dollar as reserve currency). I tend to think
> that we will not lose reserve status unless it becomes clear to the
> rest of the world that our gov't is never going to raise taxes or
> end entitlement programs in order to pay down the debt. Once default
> becomes a serious part of the endgame for the mountain of U.S. debt,
> there will be a breathtaking rush to the exits.

Jun 15 04:27 PM

[Alphameister:]

Thanks for cutting through the hype. Schiff needs hyper-inflation to validate his continued bearishness. His wish is father to his thought. Unless Obama replaces Bernanke with a political hack (not outside the realm of possibilities), we won't see hyperinflation.

Jun 15 04:59 PM

[Thomas J. G...:]

In most mba upper division finance classes the tips yield is supposed to mean the "real" interest rate, the rate you get after inflation is take out. In stable times you are supposed to infer all sorts of things about fixed rates, and future expected inflation from the tips rates. The author makes some inferences about tips yields in this article. I question that a current tips yield is a sure mathematical predictor of future inflation. Markets are used to expess and address investor concerns. If we get huge inflation people are going to run to tips because they want to get a "real" return on their money, even if the payout yield is low. That is going to distort all these future inflation predictions people think they are getting from tips. I bought tips in the early 2000's when the 30 yr tip payout yield was almost 4%. I would argue the yield dropped to because people began to understand and be more comfortable with tips. Hanke said that the time tips were mispriced and that that yield would fall, and he was right.

Jun 15 06:10 PM

[Thomas J. G...:]

In fact come to think of it, the author is saying tips yields are low and that shows that inflation expectations are low. I think I disagree with that. payout tip yields would be low in a time of high expected future inflation (it's one of few investments that preserves capital) and higher in times when inflation expectations are low (don't need tips to protect your capital. with tips you get paid inflation (as measured by the gov't) automatically. The payout yield is your remaining yield and I am predicting that if we start to get higher inflation that payout yield will drop.

Jun 15 06:17 PM

[robert.b.fe...:]

TIPs are a new commer and have no proven track record.

Jun 15 06:39 PM

[Market Sniper:]

Hyper inflation is a CURRENCY event. It is not your Daddy's type inflation under Jimmy Carter. The fiat "money" to be valid, must have the following "This note is legal tender for all debts public and private." What happens WHEN/IF confidence in that fiat is lost? when nobody will any longer accept it for goods and services? Yes, you MUST accept it in payment of debt but it ends there. Does anyone honestly believe that "money" created out of thin air has any intrinsic value? What happens when all that "money" comes home to roost from overseas, beyond the control of the Federal Reserve? We have misused and trashed the "dollar" by taking advantage of our edge. That edge being the world's reserve currency. There is a tsunami tidal wave of dollar fiat sitting off shore. When it arrives, we shall then know the true meaning of living beyond our means. Nothing anyone can do about that now as, politically, the alternatives are not acceptable. History speaks loudly on the issue and the CONSEQUENCES for imprudent fiscal and monetary policies and actions are carved in stone.

Jun 15 06:45 PM

[MGA_1:]

You can't have hyperinflation without continued government money printing. If the government stops printing money, then the inflation stops. If *all* the money oversees comes back to the us at one time & people cash out there savings, yes we will have an awful inflationary episode, but that will stop if the money printing isn't there.

From what I've read the factors leading to hyperinflation are:
* Large govt deficits
* Borrowing to support those deficits
The govt needs to monetize the debt directly. The game's over when the govt has to monetize the interest on debt.

Unfortunately, our situation looks a lot like Argentina before their hyperinflationary episodes in both 89' and 2000.

Jun 15 06:55 PM

[Market Sniper:]

I seem to remain a voice in the wilderness on the issue of hyper-inflation. Need to read up on history to understand where hyper-inflation comes from, it comes from the WORST of economic conditions. this country has experienced it twice. Once during the Articles of Confederation..the Continental Dollar and then in the south during the Civil War...the Confederate Dollar. The first lead to the US Constitution and the second lead to defeat in War. Check out conditions in Weimar Germany as a more modern example. We keep hearing that "this time it is different." I agree. This time it IS different. For the first time in history, it is world-wide. Every Central Bank, including the one in China, is engaged in competitive devaluation of their fiat. We do not have a floating fiat system. What we now have is a system where fiat SINKS at various rates. Does the Fed pullback in time and drain the "liquidity"? Based on a no recovery scenario, how can they? They are far down the road with this already. History should be your guide as to what is at the END of the road we are on. Nothing good, let me assure you.

Jun 15 10:28 PM

[Ken P:]

I don't believe that deflation will occur because the government(s) are determined not to allow that to happen. The way to ensure that deflation doesn't happen is to inject more money into the system. With fiat money there is no limit to how much money can be created. That is a recipe for hyper-inflation because at some point there will be too many dollars chasing too few products.

Jun 16 12:14 AM

[formosan_be...:]

Inflation benefits the borrower (at fixed or sticky rates) at the expense of the lender.

real growth = nominal growth minus stated inflation

true inflation = stated inflation plus the fudge factor

Substituting into our formula:

real growth = nominal growth minus true inflation minus fudge factor

The US government is the big borrower and coincidentally the US gov't compiles the statistics for inflation. The fudge factor is really a component of stated inflation, but the stats will have it show up as part of nominal growth and claim it as real growth. TIPS pay out based on stated inflation, not true inflation.

TIPS are a weak proxy for true because real growth is generally overstated and real inflation is usually understated.

I'll stick with Schiff's thesis. Thanks for trying to offer an alternative argument, albeit a weak one.

Jun 16 01:44 AM

[greed is 0:]

A dangerous game this.

Printing excess dollars and borrowing creates hyper inflation. Energy prices skyrocket which is not measured in inflation but causes untold inflationary pressures. The resultant upward price pressures kill the consumptive capability of the remaining dollars which forces deflation and the realignment of value.

In the meantime, the cost of living rises and more people fail which leaves fewer and fewer consumers alive and well. There are only so many lifeboats and as on the Titanic, only the lucky minked will survive. Those from 2nd class down will drown.

Jun 16 05:29 AM

[376602:]

Some leaked estimates by the Secret Service are seventy-precent of 100 dollar bills now circulating in the international markets were printed in Venezuela, Iran or North Korea, take your pick. "In Obama We Trust".

Jun 28 04:57 PM

[GoneFishing_73:]

Some reasonable comments but a lot of people (especially goldbugs) that were disappointed that this article didn't blindly confirm their investment thesis.

Nov 25 03:00 PM