Why Hyper-Inflation Fears Are Exaggerated

Includes: DIA, SPY
by: Thoughts Worth Thinking

It’s in vogue for commentators to warn that the booming federal deficit will cause hyperinflation. However, these commentators rarely acknowledge counterbalancing forces that make this scenario—out of control inflation far beyond run-of-the-mill price increases—unlikely.

The first flaw in these alarmist arguments is the presumption that the budget deficit the United States is now running is inherently irresponsible. Commentators stir up fears that the ballooning deficit puts the United States triple-A credit rating at risk. These arguments disregard that tax rates in the United States are much lower than in other Aaa rated countries. In evaluating the resilience of triple-A countries to expand their balance sheets, Moody’s observes that United States tax rates average 34%, as opposed to 44% in Germany and 50% in France, so that the United States’ unused revenue raising power should be considered in reviewing its credit rating. 1 Similarly, Standard & Poor’s (owned by McGraw-Hill (MHP)) considers already-high taxes to be a constraint on fiscal flexibility negatively affecting a sovereign’s credit rating, implying that currently low taxes are a favorable indicator of fiscal flexibility. 2

Second, inherent in the hyperinflation gloom and doom is the presumption that the expansion of public debt will not be followed by growth. It’s true that if all that happens is that the U.S. prints more money, the rest of the world will figure this out and value of each dollar will decline, fueling inflation. But the value of a currency is based on a range of factors far beyond whether or to what extent a government is printing money, including the value to the rest of the world of what the country is producing.

In other words, if the U.S. accelerates its development of globally desirable goods and services, buyers abroad will need dollars to purchase them, creating upward pressure on the dollar to counter the dilutive effect of printing money. Thus, running a deficit is not inherently wrong. The real question is whether the combination of public and private sector investment is likely to lead to growth.

Another way of looking at this is as it concerns the United States’ credit rating is that it’s not the deficit itself that puts the country’s triple-A rating at risk, it’s the shock of the crisis itself. Rather, the deficit is byproduct of the solution currently being implemented, which could either help or hurt the credit rating depending on the quality of the result.

It’s too early to tell how much the Obama stimulus package, subsequent government efforts, and private sector activity will contribute to real growth in the United States. But that means it’s also too early to assume hyperinflation is coming. While it’s always a good idea to diversity and I would never discourage anyone from putting some of their holdings in defensive assets, those who bet heavily on hyperinflation right now risk being disappointed.

Disclosure: The author does not hold a securities position in Moody’s or McGraw-Hill.

  1. Moody’s, “How Far Can AAA Governments Stretch Their Balance Sheets?,” February 2009, pp. 11-13.
  2. See “Standard & Poor’s, Soverign Credit Ratings: A Primer,” March 15, 2004, pp. 7-8.