Inflation vs. Hyperinflation: The Crucial Difference

by: Justice Litle
"Hyperinflation." You've heard the word. You may have talked about it on the golf course or at the dinner table. (Or even in the grocery store.)
There is a difference, though, between inflation and hyperinflation. They are not the same thing. And for the most part, there is no gradual path from one to the other. To wind up with true hyperinflation, some very bad things have to happen. The government has to completely lose control - the populace has to completely lose faith in the system - or both at the same time.
Consider the era of the late 1970s, a time of severe inflation in the United States. That was a bad scene. But did it count as hyperinflation? No, not anywhere near it. Federal Reserve Chairman Paul Volcker, aka "Tall Paul," came in and nipped that problem in the bud.
America had to undergo severe economic pain as a result of the Volcker interest rate hikes. But the point is that America had the ability to endure it -- to solve the problem with the right leadership. Things had not gotten so far gone that the populace lost faith, or the government lost control.

Faith in the Monetary System

Faith in the system is another very important concept. And it is very hard to kill. By faith I don't mean liking what the government is doing, or being happy about where the direction of the country is going. I mean basic things, like keeping your money in the bank.
Here are a few simple questions to determine whether you still have "faith" or not:
  • Do you still have a meaningful amount of cash in checking or savings accounts?
  • Do you rely on electronic payment systems (credit cards, bill pay etc.) for most of your transactions?
  • Are you still comfortable with your employer paying you in legal tender -- or, if you own a business, with your customers paying in same?
  • Does the percentage of your net worth tied up in physical hard assets, i.e. metal bars you can drop on your foot, count as less than 50%?
If you answered yes to the above questions, then guess what -- you are still invested in the functioning financial system as we know it. You still have "faith"... not in your heart but in your deeds.
Don't feel bad about this, by the way. I still have faith in the financial system too, as based on my day-to-day habits. This is only rational after all. Do you know what a pain it is to really go cold turkey? The only way to well and truly go "off the grid" involves physical barter and organic farming. (Not to mention guns and ammo.)

Inflation Versus Hyperinflation

High inflation, even double-digit inflation, can be handled within the confines of the system. The unofficial inflation rate in Argentina is somewhere around 25% right now, and people aren't even rioting in the streets. They aren't super-happy, obviously, but they are adjusting. (The government is pumping up wages, so that may have something to do with it.)
Hyperinflation, in contrast, means that all hell has broken loose. To get true hyperinflation, the economic engine has to break down... or there has to be a clear sense the government has lost all control.
This is why hyperinflation tends to come in the aftermath of wars, or at the tail end of badly mismanaged regimes where the economy has been going from bad to worse for a very long time.
The possibility of rapidly accelerating inflation in the United States is very real. When talking about sticker-shock effects like $7 for a gallon of gas, or a triple in the price of a gallon of milk, that is inflation run rampant.
But hyperinflation is a much darker prospect. To get to that point, cash has to be seen as not just undesirable, but worthless. And not just worthless in an abstract "look what the currency is doing" sense either, but real-life nitty-gritty panic mode: Making an emergency trip to the grocery store as soon as the paycheck hits on Friday, knowing that prices will go up again on Saturday. Buying two months of food at a time... fighting for the last loaf of bread on the shelf... turning off the heat because the gas bill is double the rent.

Hyperinflation in the U.S.

Is it possible for hyperinflation to happen in the United States? I would argue yes, but neither quickly nor easily. Americans won't just wake up one day and say "Gosh, look at that."
In fact, to get to U.S. hyperinflation, I believe something else would have to happen first -- the onset of a new Great Depression scenario, even worse than the last one.
Already the deficit hawks are yelling and screaming. In respect to high inflation risk, voices of great concern are increasingly being heard. In Washington, this is playing out as dramatic lip service to austerity. They are talking about massive budget cuts again, and the timetable for raising interest rates.
So here is the thing: If the inflation problem becomes too serious for the hawks to be ignored, eventually the Federal Reserve will be forced to cave in. Someone, somehow, will pull a "Volcker" and hit the inflation mule over the head with a sledgehammer.
This "Volcker action" could then trigger a collapse in the value of paper assets, as all the rebuilt Ponzi schemes pumped with Federal Reserve money come tumbling down again. The underpinnings of the U.S. economy were much stronger in Volcker's day. There was far less debt and leverage built into the system.
Or, in the absence of a Volcker-style austerity move from Washington, the stock market could crash on its own, as investors realize the stimulus rainbow has delivered them to the edge of a cliff. Either way, some aggressive action will be taken to stop the build-up of inflation, be it through Washington policy backlash or the organic effects of another Wall Street meltdown.
(As a side note, China and the Middle East are two other strong candidates for "meltdown catalyst." If the China miracle implodes, the global economy goes with it. If the Middle East goes up in flames, oil becomes the $200 a barrel grim reaper.)
When this happens -- some inflation-stopping event dropping the recovery in its tracks -- positive sentiment will quickly collapse. Recovery stats will then collapse along with sentiment. The dreaded "D" word, deflation, will be back on everyone's lips.
That is one of the great ironies at this juncture of financial history. The deflation monster still has not been vanquished! It is simply hiding under the bed, biding its time until the Fed-and-China-created stimulus bubble pops.
And when that bubble does pop, that's when things get really frightening. When the global economy endures some domino chain combination of Japan/Middle East/China/America implosion, the threat of Great Depression 2.0 comes roaring back, bigger and uglier than before (as all the extend and pretend actions taken until now have only made the problems worse).
That is the point where true panic comes in, when the attempt to stop "normal" inflation triggers an economic collapse that rivals Great Depression conditions. At that juncture, it will be apparent to all that the Federal Reserve has run out of bullets - that "more stimulus" simply cannot work - that trillions have already been thrown down the drain.
It is then, when the monetary authorities wet their pants in the face of a new deflationary panic, that the real threat of hyperinflation returns to the fore. If all hope becomes lost in a hopeless situation, we could see the Fed desperately propose something like QE2 times 10, on the order of not $600 billion but $6 trillion. That is when the real horror would begin.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.