The Great Inflation

Includes: CEF, SSRI
by: Jason Tillberg

The title of my article is the title of a book I recently got from the library. It was written in 1975 by William Guttmann and Patricia Meehan and is about the period in Germany from 1919 - 1923.

The title of Chapter 1 is "A license to Print Money" and starts off with a quick story from a play written a century prior called "Faust" by a famous German Poet named Goethe. In his play, there is a scene where the Emperor, who sold his soul to the Devil, Mephistopheles, is lacking money and asks the Devil to create it. The Devil accepts this task and a prototype note is created and multiplied a thousand times by magicians overnight. The Chancellor then gives the Emperor the note that has turned an ill into a good.

The authors go on to write on pg. 42 from this book:

It is fitting that licence to print money should have originated with a spirit akin to the Devil, the father of lies. The currency of Germany during the inflation years was a gigantic lie, which the nation recognized for what it was only in the last stage. (emphasis mine) The road to inflation, like the road to hell, is paved with good intentions, and it was to turn "ill into good" that the German government gave the licence to print money.

I can't help but recall the speech our Federal Reserve Chairman, Mr. Ben Bernanke, gave in November of 2002, known as his Helicopter Speech, in which he stated:

The U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost.

I'm in no way suggesting any of our members of Government or Federal Reserve have made any deals with the devil. Although the lesson is that the intentions may well be benevolent, to turn ill into good, i.e. cut taxes and run massive deficits to provide long unemployment benefits (99 weeks), free healthcare, food stamps for 1 in 7/8 citizens (non citizens?), etc., the future ramifications may well be disastrous and lead to ruin. Whether or not we're on the road to hell is to be seen, but we're more or less playing our cards, moving our pieces in this game that has that particular outcome if not played right.

Ron Paul puts it this way: (Sic) Money does not grow on trees for if it did, it would become as leaves do, either bagged up and thrown away or chopped up and used as mulch.

The Germans didn't realize that until 1923 (ultimate collapse was in November of 1923) when in fact, the money was bagged up, burned to heat the home and used to wallpaper walls. Believe it or not, in the summer of 1922 in Germany, unemployment was less than 1%. (pg. 26) Since the mark was so weak, demand for German exports was very strong, thus taking advantage of cheap German made goods. Ill of unemployment turned good.

The German hyperinflation experience is one we can all learn from. Investing or even preserving our wealth is serious business and demands a fierce objective analysis.

We've already seen the massive explosion in the Fed's monetary base (the ultimate measure as best I know, I could be wrong, of how much printing our Fed is willing to do) and there is no telling how much higher or when the printing will resume as there are many ills out there, from state budget deficits to unfunded pensions to a broke FDIC, under-funded Fannie (FNM) and Freddie (FRE), 30 million working age Americans either unemployed or underemployed, etc.

Click to enlarge images

I'd like to remind Americans that in 1792, our Coinage act, section 19 had a strict law that the debasement of coin was punishable by death. Founding Fathers knew of the evils of debasement of currency.

Fast forward nearly 200 years, since we have been off the gold standard August 15, 1971, the US (via Congress) has more or less given the Federal Reserve the license to print money - with benevolent intentions of low unemployment and stable prices.

I'll let you draw your own conclusions about whether we'll see more deflation from credit contraction or inflation from money printing disbursements via more Government Transfer Receipts (social security, medicare, food stamps, unemployement benefits, etc.). See 2 charts below.

Total Loans and Leases at Commercial Banks

Total Personal Current Transfer Receipts

But, if we are on the road to hell and we're destined for a stage when it turns out our currency was a big lie, like Germany's, then there are ways to perhaps increase chances of preserving one's wealth.

In Germany's hyperinflation road to ruin, there were winners and there were losers.

From this book, there is a chapter on the winners and a chapter on the losers. I'll summarize briefly, the winners and the losers.

Winners in Germanys' hyperinflation:

Anyone who either had foreign currency, gold, silver, or earned incomes in foreign currency. One example is foreign students in Germany who had been receiving their allowance in Swiss francs or British pounds, found themselves rich and able to buy German Real Estate at highly depressed prices in their native currencies as well as increase their standards of living by staying in the best hotels, attracting the prettiest girls, etc.

Importer/Exporters who had access to foreign currency and could hold those currencies for a few days extra before converting to German Marks to profit from the exchange rate change.

Bankers/Money Changers exploited this situation for their own gain by trading in the currency markets and using to their advantage the time before converting back to marks in their trades. (Those folks were later highly resented.)

Renters: Rent control kept rents of flats (a great majority of German people were renters) down, making rent payments by 1922 constituting less than .5% of total household incomes, next to nothing. (Landlords of residential buildings lost out greatly as not only were rents low but fixtures and anything else of value in many cases were stolen to be used to barter for food.)

Those that were privileged to have taken great advantage of Germany's poor state of money, particularly those with access to foreign money or able to borrow foreign money, were able to buy Germany's best assets, mines, real estate, factories, etc. or simply live the life of luxury on the cheap during the times of the weakest Mark. The key factor is simply having foreign capital. Again however, the German people didn't quite realize what was happening to their currency until it was too late.

Owners of agricultural land and industrial premises.

Artists: Physical items that would hold value were in high demand, so top German artists works were in high demand.

Those with debts: The debts were simply inflated away. (Don't get any ideas because this road is a road to ruin. However, there is no easy choice out of the current state of US debts, both public and private, and inflating it away is unfortunately one means of ridding ourselves of all our debts and starting over; preferably without an evil dictator ruling over us as a consequence.)

Losers in Germany's Hyperinflation

Losers were ultimately the German people. Much of the German middle class was destroyed. (pg. 122) When you debase currency, you debase civilization. History proves that over and over again and again.

Those most affected and least able to provide for themselves included the many who were living on pensions or received income expressed in fixed money values, like life insurance policies, state securities, municipal and other bonds, war bonds and mortgages. Those who had claims against debtors basically.

Those who worked for the Government, be it civil servants, judges, teachers, scientists, academics, etc. who received wages of ever increasing marks, but not enough to maintain the standards of living they were accustomed to.

The key takeaway from this very brief summary of this book I highly recommend reading, is that when you have a license to print money, you are doing dangerous work that may well lead to ruin, so great caution must be taken, to prevent us from going the way of Germany.

Diversify into asset classes that stand to do well in the event of further debasement of fiat currencies. Ideally, gold and silver are one way. I own Central Fund of Canada for clients (NYSEMKT:CEF) and Silver Standard Resources (NASDAQ:SSRI) as one way to hedge if that printing press goes into further overdrive.

Think about owning physical assets like art, antiques, farmland, industrial premises and in the worst case scenario, if you're on a fixed income from the Government for example, learn to raise chickens for laying eggs. On page 172, there is a picture of a barber accepting eggs as payment for a shave and a hair cut. Shave = 2 eggs, haircut = 4 eggs. A hen can lay an egg a day by the way.

We simply don't know how our Fed will steer our currency. It's ultimately in their power to determine the cost of money (interest rates) as they have a near monopoly on that front . Congress has the power to determine spending (quantity of money available). We know the Fed has a printing press that can create money at essentially no cost (no cost, right).

In the end, I agree with Goethe and Ron Paul, printing money is the devil's work (Goethe) and will lead to a collapsed currency and state of ruin (Ron Paul). Debase the dollar and you debase America, one could argue. We may get a brief period of strong exports, like Germany in the summer of 1922, but that's a one trick pony.

Disclosure: Long SLV, SSRI and CEF for myself, clients or both