Don't Expect Hyperinflation for U.S. Economy

Almost everyday we hear some new doomsday scenario about the US economy. It goes like this: in its attempt to save the financial sector, the Federal Reserve and the US government have set up an economic disaster. Strategies like quantitative easing, TALF, and massive government spending threaten to create a hyper-inflationary environment by burgeoning the money supply. In effect, poor fiscal and monetary policy has put the US economy on the road to disaster. In theory, this scenario is probably true because it operates as economic theory would dictate. In practice, however, this scenario is highly unlikely. Below are some reasons why this hyperinflation scenario is improbable.

Interest Rate Policy: The FED Funds rate is currently sitting at an all time low of 0.00-0.25%. While low interest rates have substantially expanded the money supply, they also give the FED leeway in conducting its monetary policy. The recent news buzz around a possible FED hike proves that the FED is ready to raise interest rates to help shrink the money supply when inflation returns. Additionally, expectations shape reality. Because consumers and firms believe that the FED will keep inflation under control, they will be less inclined to chase after goods to beat rising prices. The result of this psychological effect is clear: less money chasing goods means less inflation.

The Location of the Money Supply: Almost all the money from FED liquidity and securities purchase programs is either sitting on bank balance sheets or in a bank’s reserve account at the FED. In effect, the massive growth of the money supply has been limited to the financial sector. In order for prices to rise, however, this money would have to leave financial sector and enter the hands of consumers and firms. Tight credit markets ensure that this money doesn’t leave the financial sector. Additionally, a large amount of this “printed” FED money will have to be paid back when the economy improves. This requirement acts as an automatic stabilizer on the size of the money supply: when the prospect for hyperinflation is the greatest, during economic recovery, the money supply will shrink.

FED Debt: Even though the Federal Reserve has refrained from asking Congress for the authority to issue its own debt, it is very likely that it will ask for the power (and be given it) when the prospect of inflation becomes more real. FED debt would easily soak up excess and hyperinflation threatening liquidity in the financial system. Because a large amount of the “printed” money from FED programs is stored in banks’ reserve accounts, FED debt is an obvious and logical choice to shrink the size of the money supply.

The Unknown: Coming into the financial crisis, we had no idea what the government was going to do to attempt to solve the problems raised by the crisis. The same holds true for hyperinflation. With midterm elections coming up in 2010 and a presidential election coming in 2012, the last thing the Obama administration wants on its hands is hyperinflation and comparisons to the Carter administration. For this reason, it seems highly probable that in the event of hyperinflation or anything close to not normal inflation, the government will likely implement some Draconian measure to curb inflation. While this measure will probably substantially damage the US economy, it will keep hyperinflation in check.

Disclosure: Long TBT.

Comments

[DONE_SONZ:]

The main cause of hyperinflation is a massive and rapid increase in the amount of money, which is not supported by growth in the output of goods and services.

Jun 21 09:12 AM

[tjmmz9843:]

It's spelled "Fed", not "FED". It's not an acronym.

Jun 21 10:11 AM

[Whale:]

I read your article and I want to be polite but you have no idea who the Federal Reserve is, who owns them, and how they enslave everyone who uses their currency the U.S. dollar. There is a guarantee of two things, deflation, then inflation, and here it comes. Guaranteed.

Jun 21 10:39 AM

[GaryBG:]

If debt in this country continues to be destroyed thru losses on mortgages, business and personal bankruptcies by the score, credit card write offs, diminished asset values which require balance sheets to either be replenished with additional capital or a much smaller entity, doesn't the issuance of $billions of Fed dollars replenish some of the destroyed dollars? To what degree will they have to overshoot to cause massive inflation? Jeremy Grantham makes an argument that $10 Trillion+ of debt will have to be written off over the next 6 years. Were the Fed not supplying a gigantic amount of dollars, would be not be destroyed by a lack of dollars?

Jun 21 11:07 AM

[cameroni:]

Richard, you are an optimistic guy and I can see how you might place confidence in the government, Fed and their bond apparatus to solve the problems before they go out of control. But it won't go down like that. This problem is here to stay.

The dollar has steadily been eroded and lost most of it's value over the past century. That process is just going to be accelerated from here on in and the building blocks to hyperinflation are almost all in place.

I would not get too starry eyed about the Governments potency to squash inflation once it sets in nor it's ability to control rates. You need leverage to have control and policies that brought us to the current debt crisis means that leverage has been substantially handed to our creditors.

Do you name the rate when you walk into your local bank and apply to take a mortgage? I don't think so. In any event we already know that we can experience high inflation and high interest rates simultaneously. And it is really destructive to some enterprises. We lived those two events together in the early 80's. But those were different times and we recovered eventually after some major structural changes.

Lastly, you did not even touch on the issue of unfunded liabilities, Boomer retirements or how the administration will be paying for new Medicare programs. The debt balloon does not even take into account any new military ventures. (There will be one of course, be it Korea, Iran, Pakistan etc). How will that be paid for without further destroying the currency? And what Draconian measure do you think would then prevent a currency failure?

I would hazard to guess that the currency will just simply be allowed to die much as it did in Israel in 1979. The debts were paid off and the Shekel became the substitute for the old Israeli Lire. The world did not end in Israel in the early 80's either and the country made a full recovery. A hyper-inflationary event can be convenient for a Government that has run out of solutions, is indebted and has no more leverage over it's creditors. You see, you get to start fresh again. Just like any bankruptcy.

Cam

Jun 21 12:51 PM

[CautiousInv...:]

The monetary base, which includes reserves held at the Fed, has exploded but, as the author notes, is within the financial sysytem.

M1 is a fairly broad measure of money supply, which excludes money at Treasury and the Fed, and it has expanded at a 16% rate over the past year. The only thing prevent this from becoming a problem.......at the moment.... is the velcocity of money.

The big issues facing the Fed are (1) calibration: the process of reading and responding to market signals (2) the quality of some of the assets held on its balance sheet and its ability to unwind its position in these assets (3) political pressure to continue monetary easing in the face of inflation should the economy still be fragile (4) potential capital losses on securities and (5) political blackmail.

One, two and three are self explanantory, while four and five are a bit more subtle but have been dicussed at some length by Willem Buiter. Following herewith are his concerns:

As for the Fed’s independence (whatever independence remains), first, even if the central bank prices the private securities it purchases appropriately (that is, there is no ex ante implicit quasi-fiscal subsidy involved), it is possible that, should the private securities default, the central bank will suffer a capital loss so large that the central bank is incapable of maintaining its solvency on its own without creating central bank money in such quantities that its price stability mandate is at risk. Without a firm guarantee up front that the Federal government will fully re-capitalise the Fed for losses suffered as a result of the Fed’s exposure to private credit risk, the Fed will have to go cap-in-hand to the US Treasury to beg for resources. Even if it gets the resources, there is likely to be a price tag attached – that is, a commitment to pursue the monetary policy desired by the US Treasury, not the monetary policy deemed most appropriate by the Fed.

Jun 21 01:01 PM

[Michael Clark:]

We are in a deflation depression. The prices of everything but computer chips have accelerated at ridiculous levels. Salaries have been compressed by globalism -- but purchasing power of workers was salvaged by lower interest rates which encouraged workers to become debt slaves. Now consumers are aware of their vulnerability to debt and job-loss. The big spending era is over.

Do we need a period of deflation?

Do we really need an economic deflation? Yes.
I worked for thirty years in administration at the University of Oregon. Each year, as part of my tasks, I developed a statistical study for the department. One such study centered on the cost of tuition for students.
From 1976 to 2007, University of Oregon full-time tuition for undergraduate residents of Oregon climbed from $216 per term to $2107. This is an increase in thirty years of 875%.
In the same time, full-time tuition for non-resident graduate students increased from $320 per term to $5447 per term, an increase of 1602%.
To put this in perspective, a person earning $20,000 per year in 1976 (a reasonable salary at the time), would need to be making $320,400 in 2007 in order to keep up with this suggested inflationary rate.
A person earning $60,000 in 1976 (a higher administration type salary), would need to be making $961,200 in 2007 in order to be keeping up with this inflationary rate.
Not many job categories have increased at this rate. Some have: CEO’s of elite American businesses, successful founders of technology or biotechnology companies, or internet start-ups, Wall Street investment bankers, perhaps doctors and professional and college football coaches. But most Americans have not seen this kind of inflation of salary rates.
It is not just higher education which has inflated so dramatically.

Health care insurance premiums have increased nearly 10% per year for the last 10 years. I didn't get a raise the last 10 years when I was working because my employer could not afford to give me a raise AND give the insurance company a 10% raise on my health insurance benefit.

When I was entering college in 1970, a new Volkswagon bug cost $1000. Today, a new bug costs $20,000. This is an increase of 1900%. A person making $20,000 in 1970 would need to be making $380,000 dollars today to keep up with that inflation rate.

Then, of course, there are housing prices.
My sister-in-law in Portland, Oregon bought her house in 1988 for $71,000. This was a modest three-bedroom house in a modest part of Portland. She and her husband had just emigrated from Vietnam; both she and her husband were working jobs starting at close to minimum wage. She had $3000 in savings and borrowed another $4000 from her mother to secure a 10% down-payment. In 2007, this house was valued at $700,000. In 2008, Portland housing declined about 10%. A house that has increased in value from $71,000 in 1988 to $630,000 in 2008 has increased 787% in twenty years. A couple making $30,000 in 1988 should be making $236,100 in 2008 in order to keep up with the suggested inflation rate designated by this gain in housing.
Talk about ‘global warming’!

Jun 21 01:11 PM

[Econ Base:]

The Fed is desperately trying to create inflation. They will succeed eventually, because they are printing money. It will take some time however, because 1) the US consumer is in a mood to save and 2) Joblessness will rise.
Stay very cautious in these uncertain times.
Read: portfolioforlife.blogs...

Jun 21 01:12 PM

[Living4Divi...:]

I disagree with the author. I'm in the inflation is coming camp. I'm an inflationista.

Ludwig Von Mises put it best when he said:
" There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crises should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved."

In the last year, TIPs have widely diverged from nominal Treasuries. I did a chart comparing nominal Treasuries with TIP. that demonstrates this. Since I can not post charts in the comments section, if you want to see the chart go here:
seekingalpha.com/artic...

Jun 21 01:24 PM

[Mono:]

interesting read

i am never one to belittle one's opinion or pretend as though mine is more persuasive. i appreciate the authors ideas and writing. thorough yet simple. unfortunately i do not agree with a main part of the argument as to where exactly the money has gone and how much has truly been used or printed.

im sure many have already seen this but you can skip to 1:22 into it. i could rebuttal intensely but for lack of time....

www.youtube.com/watch?...


On Jun 21 01:01 PM CautiousInvestor wrote:

> The monetary base, which includes reserves held at the Fed, has exploded
> but, as the author notes, is within the financial sysytem.
>
> M1 is a fairly broad measure of money supply, which excludes money
> at Treasury and the Fed, and it has expanded at a 16% rate over the
> past year. The only thing prevent this from becoming a problem.......at
> the moment.... is the velcocity of money.
>
> The big issues facing the Fed are (1) calibration: the process of
> reading and responding to market signals (2) the quality of some
> of the assets held on its balance sheet and its ability to unwind
> its position in these assets (3) political pressure to continue monetary
> easing in the face of inflation should the economy still be fragile
> (4) potential capital losses on securities and (5) political blackmail.
>
>
> One, two and three are self explanantory, while four and five are
> a bit more subtle but have been dicussed at some length by Willem
> Buiter. Following herewith are his concerns:
>
> As for the Fed’s independence (whatever independence remains), first,
> even if the central bank prices the private securities it purchases
> appropriately (that is, there is no ex ante implicit quasi-fiscal
> subsidy involved), it is possible that, should the private securities
> default, the central bank will suffer a capital loss so large that
> the central bank is incapable of maintaining its solvency on its
> own without creating central bank money in such quantities that its
> price stability mandate is at risk. Without a firm guarantee up front
> that the Federal government will fully re-capitalise the Fed for
> losses suffered as a result of the Fed’s exposure to private credit
> risk, the Fed will have to go cap-in-hand to the US Treasury to beg
> for resources. Even if it gets the resources, there is likely to
> be a price tag attached – that is, a commitment to pursue the monetary
> policy desired by the US Treasury, not the monetary policy deemed
> most appropriate by the Fed.
>
>

Jun 21 01:31 PM

[Michael Clark:]

Here is an interesting read on the deflation/inflation argument:

rosemanblog.sovereigns...

Jun 22 01:33 AM

[MGA_1:]

Hyperinflation is certainly not guaranteed, but the large deficit spending going into a heavy recession sets us on that path. Currently, the banking system is holding onto the money - if the economy has a spurt, then yes, that money could come tumbling out. The thing I'm watching for is how the upcoming govt debt is paid for - will the open market accept it or is the fed going to have to monetize. Purchase of t bills by the fed is directly inflationary.

Just a note that Argentina's hyperinflation really kicked into gear when their central bank tried to mop up liquidity with high yielding central bank bonds. Problem is they had to pay interest on them which ended up being a terrible cycle. We're not there yet, but I wouldn't completely rule hyperinflation out as a possibility.

Jun 22 10:25 AM

[Ferdinand E...:]

Interesting article and comments. Both article and comments deserve to be discussed in a seminar room and not on the bloggosphere, I certainly hope that the author is correct.

Jun 22 11:28 AM

[Jimbo:]

Michael Clark: I thought your comments were most intriguing. Permit me one quibble: I entered graduate school in 1959. A fellow student bought a new VW Bug and paid $1,695 for it.

Jun 22 12:21 PM

[Michael Clark:]

I grew up in Southern Wyoming. It always took everything a bit longer to get to us -- even higher priced VW bugs I guess. Thanks for your note.

MJC


On Jun 22 12:21 PM Jimbo wrote:

> Michael Clark: I thought your comments were most intriguing. Permit
> me one quibble: I entered graduate school in 1959. A fellow student
> bought a new VW Bug and paid $1,695 for it.

Jun 23 06:38 AM

[Bill Goode:]

It's the simple law of supply & demand. The Obama administration coupled with Congress is set on creating money to no end. Very little of it gets printed any more. Now days they simply add zeros in the computer to the banks' holdings. Of all the "money" presumably created by the Federal Reserve, only about 3% of it actually gets printed. They don't even have to print it any more. They just add zeros. Is that counterfeiting? Who knows! But hyperinflation is on its way. Last week Congress decided to bless our economy with an environmental bill that will further drive manufacturing out of the country. Federal government health care looms on the horizon. And Mr. Graham thinks that the trillions of dollars that were "created" are in the financial sector will have no effect on the citizens? Who does he think he is kidding? Does Mr. Graham work for a bank or the Federal Reserve?

Jun 29 09:50 PM

[Goingfwd:]

Inflation is comming the only questions are: when, how much, for how long and how quickly will it rear it's ugly head? The feds know it is comming and that is why you are seeing a rush to cram through all of these controls (healthcare, Crap and trade, etc) Obama promised to reduce the US debt by half, the only way this could possibly happen even based on 2008 debt numbers is for there to be a major devaluation of the dollar. With all of the new spending, it will be his only hope for a second term. If you can control through your unelected czars, major industries ike the financial sector, automotive, transportation, healthcare and energy then you can control the people and prices as well. This would allow for a brief period of hyperinflation to take place without major riots and a total collapse of the government entities. As you can see, they are paving the way for instigating a hyperinflationary situation it will give them the window of opportunity to pay down the massive debt. The flaws in the idea are obvious, but what they are counting on is their ability to control every aspect of the economy through these Czars who answer to no one but the President himself. Pay Czar?

Jul 12 03:28 PM

[retired avi...:]

Even the large money supply increases very likely to come need not cause price inflation at an unusually high rate. See my website.

Aug 07 12:36 AM