Hyperinflation Trade Looking Crowded

As the Federal Reserve continues to print money, the “hyperinflation trade” seems to be a crowded one.

The premise seems sound and reasonable; whenever a government prints money and devalues its own currency, rising prices follow. A deflationary environment cannot hold for a sustained period of time, because the government will print money, or drop dollars from helicopters, or do whatever it needs to do to create price inflation.

But is it really that simple?

If so, then gold is playing one hell of a rope-a-dope on all of us. Why has gold not been able to crank past the $1,000 mark decisively if inflation, and perhaps hyperinflation, are in the cards? After all, the market is supposed to be a forward looking mechanism!

Perhaps gold is merely climbing the “wall of worry” on the way to the final mania stage, doing a fine job at shaking out the weak hands and non-believers before ultimately skyrocketing to $1500…$2000…or higher.

Gold has risen each of the last eight years versus the dollar, and appears poised to extend that streak again this year, so maybe I’m being overly harsh.

However thus far, plays on hyperinflation have mostly disappointed. Sure, gold has rallied off it’s lows, but so have the broader markets, in what appears to be a textbook bear market rally.

Recently I’ve started wondering if there’s something fundamentally wrong with the hyperinflation hypothesis. A few weeks ago, I mused that the “buy gold” trade seemed a little overdone, at least in the short term, punctuated by Northwest Mutual’s purchase of gold for the 1st time in the company’s 152 year history.

When insurance companies are rolling up to the party, you can bet the cops are also on the way and ready to shut the joint down!

So please indulge me for a moment, and let’s ponder “what if” Helicopter Ben can’t print dollars fast enough.

Here’s what could gum up the efforts of the money printers – said best this month by my new favorite deflationist, Robert Prechter:

“You can’t beat deflation in a credit based system.”

Prechter says that growth in money supply requires activity on the part of lenders and borrowers. And once a credit bubble implodes, there is no way to restart the engine.

Japan’s recent deflationary recession is a classic example of this – despite unprecedented efforts by the Japanese government to devalue the Yen and generate inflation, they weren’t able to do either!

No amount of public works projects, increases in federal spending, and monetization of debt has yet been able to snap Japan out of its deflationary nightmare. When its credit bubble popped in 1989, it stayed popped for good.

Was Japan an anomaly? With the US employing the same “hair of the dog” tactics, we’re going to find out soon!

If we had a cash based economy, then printing money would indeed cause price inflation, Prechter says. But in a credit based economy, credit is being destroyed at a much faster rate than the Fed can print.

(Roughly $14 trillion in credit down the drains so far, versus $2 trillion in deficit spending and monetization…so quite a large gap).

Eventually, enough credit is destroyed that the Fed will be able to affect the money supply. So, ironically, we could see hyperinflation at the end of this all…of whatever little money is remaining!

As engaging as this intellectual exercise is, at the end of the day we need to figure out where to put our money! There is no safe haven, after all – even if you’ve got your money in cash, you’re “long cash”; and “long” the currency you’re stocking it in!

So what are we to do?

Well, I think we’ve got to watch the charts, and listen to what the market is telling us. This is a time to protect our capital, not to reach for extra yield. If an asset class is getting taken to the cleaners - get out! That was the biggest mistake I made during the Great Deleveraging of 2008; that was the time to follow your stops, go to the beach, and catch a little R&R while the world fell apart.

That said – if we see gold smoke past $1050, $1100, etc – we probably want to be in gold. We’ll take that as a cue that our musings about credit based systems, while fun, were perhaps wrong!

For now, I think cash is not a bad place to be. With gold not yet able to break through, and the hyperinflation trade getting more crowded by the day, another burst of deflation could catch most folks with their pants down.

Remember, in a deflationary environment, cash is king. So don’t worry about yield. Cash gains purchasing power as prices deflate around it. If you’re able to preserve your capital in nominal terms, we could do quite well in real terms!

Comments

[Dave Wrixon:]

What people are failing to understand is the difference between Capital Assets on one side and Good's and Services on the other, and ther differentiation of various classes.

If you own a car factory and ther market for cars evaporates it is worth zilch, as are shopping mails without customers or appartments without tenants. The largely theoretical valuations of these assets evaporates because they have no purpose.

The Good's and Services these can be broken down into essential and non-essential. We need food and heating, but there is a limit to how many cars we actually need and noobody actual needs to replace their TV with an LCD. Consequently, in a economy where credit and money is hard to come by there will be continued strong demand for certain goods and service, whilst others will have very weak demand. Hence it is possible to have traction where the rubber hits the road even on a rusting old banger of an economy.

If goods and services are traded in a global market place, the rate of inflation will largely be determined by the value of the currency.

If Bernanke has worked out how to get an ever increasing exchange rate for the dollar whilst accelerating the expansion of the Fed balance sheet, then the man is a god. If not inflation is inevitable. But my hunch is that he knows that and it is all part of his agenda. He knows that the only way Uncle Sam can pay his dues is to keep interest rates low and to debase the currency. The additional dollar printed effectively go straight in Uncle Sam's back pocket, but the value of everybodies savings and earnings evaporates. Of course the Unions are not going to sit idly by and let that happen when one of their main beneficiaries is sat in the White House.

Jun 29 05:08 AM

[Roger Knights:]

I think inflation won't happen for at least a year, and therefore a boost in gold's price will come, if it comes, from buying by China. (Gold would be a safe place to park its cash and would strengthen the Yuan and enhance China's political status.) It would make sense for China to buy gold now, before inflation sends its price above $1000.

Jun 29 05:24 AM

[rick12345:]

Japan has a savings rate of 60% while the US is lucky to reach 2%-3% during prosperity. This is the reason why inflation will rise in this country, but has thus far failed to materialize in Japan. As for the gold price, what on earth are you talking about??? The price has remained at a 20 percent plus premium for months now; I wouldn't expect the price to escalate until some concrete figures show up in the national data. Hence the retesting of the $1000 uncertainty barrier. Inflation will occur once the economy picks up and private investment begins to improve. Quantitative easing does not work, has not worked, and never will work in a free market since it operates against fundamental principles - it's like mixing oil and water together.

Jun 29 06:22 AM

[texpat:]

I have equal percentages of cash and bullion. Inflation isn't here yet and may be a while in coming. But it could arrive with fury, and no one will be ringing a bell in advance to give you time to get into bullion at bargain levels. And if central banks turn net buyers, the gold price won't even need inflation to move.

Jun 29 09:08 AM

[Danny Furman:]

If gold is "crowded" then stocks are "super-duper-mega-crow... Why shouldn't $2T/$9.5T in money market accounts be headed for PMs during such fragile times? Gold is still a generally ignored asset class and investment demand going up by 10x from nothing does not qualify as crowding. Additionally, investors buying gold are mostly buying paper "equivalents," allowing banks to further leverage their short position because nobody is taking physical delivery.

seekingalpha.com/artic...

Jun 29 09:14 AM

[Larry House:]

I agree with the premise. When so many get on one side of a trade, it has much less chance of working. Inflation seems so obvious a call. It will be interesting to see how it plays out. IF, and I stress IF, the extreme view of a depression comes to pass, that would remove inflationary pressures for some years. In a depression, everything deflates--even precious metals. Cash is king then to step in and buy at bargain prices.

Jun 29 10:18 AM

[Whippet:]

The dollar has lost 98% (a 50x decrease) of its purchasing power since 1913, in CPI terms. A $20 St. Gaudens (gold content only) was worth $20.
The gold content of a St. Gaudens is worth ~$900 today. 45x vs. 50x. Not to mention the supply:demand function has grown significantly faster on the demand side than on the supply side, and continues to do so.
Exactly how is gold "crowded"? Compared to equities? Treasuries?
I'm personally weighted toward silver- better risk:reward at this point.

Jun 29 10:47 AM

[Mayer Amsch...:]

The problem is that hyperinflation, if it doesn't turn into a long-term spiral (and I believe most of us don't think that it will), will come quickly, where the dollar will lose 50%-75% of its value in, say, two years, and then remain at that plateau for a while. In which case, stores of value should shoot up dramatically over, say, a 6 month period and people don't want to "miss the boat". I think that's why gold has stayed remarkably flat the past 5 months, everyone is holding their breath, so certain it will happen but not knowing when.

Jun 29 11:02 AM

[sarge 907:]

The government ponzi scheme is simple, yet complex beyond discription-so say the majority of our self proclaimed economist.

"Simmon" says, " If your not thinking hyper-inflation, your not thinking."

Jun 29 12:58 PM

[Whippet:]

The so called Wile E. Coyote moment...


On Jun 29 11:02 AM Mayer Amschel Rothschild wrote:

> The problem is that hyperinflation, if it doesn't turn into a long-term
> spiral (and I believe most of us don't think that it will), will
> come quickly, where the dollar will lose 50%-75% of its value in,
> say, two years, and then remain at that plateau for a while. In which
> case, stores of value should shoot up dramatically over, say, a 6
> month period and people don't want to "miss the boat". I think that's
> why gold has stayed remarkably flat the past 5 months, everyone is
> holding their breath, so certain it will happen but not knowing when.

Jun 29 01:40 PM

[CLH:]

Very good article Brett, but gold bugs dont get it. I expect inflation in about 30 years. (see Japan 1990s and US 1930s to 1970s). Im buying stocks and making the most money of my life. (I left gold in March 2008 when it topped). Never buy anything at the top (gold) but buy at the bottom (equities). The last time gold topped, it took 25 years to break even.

Gold is for frightened people who arent interested in making money.

Jun 29 02:35 PM

[Brett Owens:]

CLH: Thanks, very interesting - so is it fair to say you believe that larger, sweeping societal trends (demographics, etc) are the true drivers of inflation and deflation?

I always thought demographics are something that were really overlooked during Japan's past couple of lost decades - getting older as a nation is extremely deflationary, that's one heck of a headwind no matter how much money is being printed.

One other quote - and I can't recall who said it offhand, so my apologies - that no nation with a bond market has ever experienced hyperinflation. I haven't done the research but offhand thought it was potentially very insightful.

Jun 29 08:13 PM

[Whippet:]

Perhaps. Or perhaps "gold bugs" could also be traders, who have returned 40% YTD and prefer to hold money instead of cash, ex-trading capital. To compare this nation to Japan is short sighted and dangerous. It's your prerogative. Physical gold and silver are not for "trading"- they are an insurance policy. I and most "gold bugs" would prefer to see the status quo, high volatility, full faith in fiat stick around a while. But the writing is on the wall. With all this talk of "deflation", y'all sound more Keynesian than Lord Keynes himself... If inflation/deflation truly are MONETARY phenomena, you'll be caught holding the bag (of green and white toilet paper).


On Jun 29 02:35 PM CLH wrote:

> Very good article Brett, but gold bugs dont get it. I expect inflation
> in about 30 years. (see Japan 1990s and US 1930s to 1970s). Im buying
> stocks and making the most money of my life. (I left gold in March
> 2008 when it topped). Never buy anything at the top (gold) but buy
> at the bottom (equities). The last time gold topped, it took 25 years
> to break even.
>
> Gold is for frightened people who arent interested in making money.
>

Jun 29 10:09 PM

[Brett Owens:]

Remind me never to cross you precious metal traders...you guys are nuts!

I love it that merely suggesting the possibility of an outcome other than hyperinflation gets the troops to circle the wagons and crucify the deflationary voice! Uncle!

FYI...I don't condone money printing, and I do believe that inflation is the creation of money...meaning we already have inflation. I am suggesting the possibility that it might not matter that the Fed is printing money...if they are indeed "pushing on a string".

I don't have the answers, but I'm anxious to see how this unfolds...hopefully without losing my "investment shirt" in the process!

Jun 30 01:18 AM

[Francis Sch...:]

Can't believe nobody saw it!? Gold breached the 1,000 level months ago right under our nose...an few who noticed it. It happened in Canada and Switzerland. Even in Iceland.
PLEASE wake up: there is a lot more than $ Gold in the World. The Dollar is loosing its status as reserve currency; but because it is a reserve currency, authorities (FED) are doing all they can to avoid a 'crash' of the Dollar like the British pound experienced. The Exchange stabilization fund and the Plunge Protection Team had surely something to do with the dull price of Gold and the Dollar exchange rate. The last word however hasn't been said. Better keep your breast wet.

Jun 30 10:02 AM

[che:]

>Japan has a savings rate of 60%<

you might want to check your facts. not only japan hasn't had anything close to that rate in the past 30 years, their savings rate has been on a constant decline.

and by the way, don't talk about japan as if it's already over and is an example of "deflationary lost decade(s)". let's wait and see what happens now that their govt debt is 6x what it was in the 90s.


On Jun 29 06:22 AM rick12345 wrote:

> Japan has a savings rate of 60% while the US is lucky to reach 2%-3%
> during prosperity. This is the reason why inflation will rise in
> this country, but has thus far failed to materialize in Japan. As
> for the gold price, what on earth are you talking about??? The price
> has remained at a 20 percent plus premium for months now; I wouldn't
> expect the price to escalate until some concrete figures show up
> in the national data. Hence the retesting of the $1000 uncertainty
> barrier. Inflation will occur once the economy picks up and private
> investment begins to improve. Quantitative easing does not work,
> has not worked, and never will work in a free market since it operates
> against fundamental principles - it's like mixing oil and water together.

Jul 05 01:45 PM

[che:]

check this:
www.swivel.com/data_se...


On Jul 05 01:45 PM che wrote:

> >Japan has a savings rate of 60%<
>
> you might want to check your facts. not only japan hasn't had anything
> close to that rate in the past 30 years, their savings rate has been
> on a constant decline.
>
> and by the way, don't talk about japan as if it's already over and
> is an example of "deflationary lost decade(s)". let's wait and see
> what happens now that their govt debt is 6x what it was in the 90s.
>

Jul 05 01:46 PM

[che:]

the point i'm trying to bring home. people that say that we're moving into deflationary environment >period< compare to GD1 or Japan. well, that comparison is not really suitable. in case of GD1, govts were able to pay back all their debts because of the demographic situation (the world was young). in case of japan, well, what can i say, few people actually know that private debt has barely gone down in japan from 1991. instead what happened is govt loaded a lot of debt. japan has the highest debt/gdp ratio in the world. they are old now, their export markets are faltering. i think there could be inflation in japan after all, but nobody will like it.

Jul 05 02:03 PM

[Vimes:]

Brett, I like your net money supply calc (credit destruction vs. stimulus) but wouldn't it be more correct to
1) Compare projected future values/paths of those figures
2) Use a stimulus x money multiplier figure ?

Admittedly Japan's multiplier has remained broken for years, but if the US's picks up, that gap could close pretty quickly...

Jul 09 04:57 AM