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The Pundits Are Wrong About Hyperinflation

|Includes: SPDR Gold Trust ETF (GLD), SLV, SPY, TBT


In a July 17 interview on CNBC, Marc Faber says that "governments are delaying the ultimate crisis." Faber adds:

"If you pump money into the system and you create large fiscal deficits, you create volatility" …  "We've seen an intermediate low in March, we'll rally for a year or so or maybe 18 months -- the ultimate crisis will happen much later, and the ultimate crisis would clean the system"

In a May 27, videotaped interview with Bloomberg (see story), Faber stated that the US will experience Zimbabwe style hyperinflation:

“I am 100 percent sure that the U.S. will go into hyperinflation,” Faber said. “The problem with government debt growing so much is that when the time will come and the Fed should increase interest rates, they will be very reluctant to do so and so inflation will start to accelerate.” 

What Is Hyperinflation?

The definitions of hyperinflation vary widely, typical definitions include:

  • "Rapid, out-of-control inflation, at double digit rates per month and more, usually occurring only during wars and periods of severe political instability."
  • "An extremely high rate of inflation, often exceeding several hundred or several thousand percent, that causes a country's money to become practically worthless."
  • "Inflation at rate in excess of 50% per month."

In the aggregate, hyperinflation is inflation that is high and out of control.  Most definitions set a minimum threshold of a 50% annual inflation rate to be considered hyperinflation.

Inflation Reduces The Debt:  the U.S. is currently burdened by crushingly high public and private debt. Inflation eases the load on debtors and at the expense of lenders

How Hyperinflation Occurs

As it allows a government to devalue their debt and avoid a tax increase, sometimes governments have resorted to an extremely loose monetary policy in order to meet their expenses. If the government fails to fund expenses from taxes, new debt issues, and/or cost cutting, and instead prints money, then higher inflation results. If there is way too much of this and savers lose confidence in the currency, inflation spirals out of control and becomes hyperinflation through the following processes:

A. Inflation of Tax Receipts: Typically, there is a time delay between when taxies are levied and taxes are collected. In a high inflation environment, the real value of the taxes collected is diminished due to inflation. In order to pay taxes with cheaper dollars, taxpayers delay paying taxes, thus compounding the shortage of tax receipts.

B. Inability to Sell Government Debt: The government can’t sell its debt, except at very high interest rates. This forces the government to print currency to fund operations.

A & B are a self-reinforcing. The A & B combination forces the government to print more and more currency, compounding the problem, until inflation spirals out of control.

Hyperinflation On Purpose

During periods of warfare or civil war, governments need to do whatever is necessary to continue fighting, since the alternative is defeat. Governments purposely engage in actions that cause or continue hyperinflation to avoid military defeat.

Governments have induced hyperinflation in order to avoid a crushing debt, for example: the Weimar Republic. Overwhelmed by crushing war debts, it had no choice but to print currency to pay war repatriations. The currency devalued and inflation spun out of control, leaving the currency worthless.

The reasons vary, but the mechanism is the same: hyperinflation is always the result of a government irresponsibly borrowing money to pay all its expenses. Eventually, the debt load becomes too high to service, and the government resorts to printing money to monetize the debt. This leads to a loss of confidence in the currency, causing interest rates to shoot up making it difficult and expensive to borrow, thus increasing the need to print money to fund operations. Citizens abandon the currency and turn to hard currencies and gold.

Out Of The Frying Pan…Into The Fire

Sure, hyperinflation would wipe out the debt, but it also would:

  • Destroy the government's ability to issue debt at reasonable interest rates.
  • Make it nearly impossible for companies to issue debt or transact business.
  • Destroy the value of taxes collected by the government.
  • Destroy the lives of Americans living on a fixed income.

In other words, hyperinflation does far more harm than good to the government’s finances, and is not in the best interest of the government, nor the American people.

Quantitative Easing Is Over … For Now

In the US, it looks like the money printing spree is temporarily over for now. Brian Blackstone, in article for Barron's titled  That's About It for Quantitative Easing writes that amid huge deficits, more quantitative cuts are unlikely:

It looks like the U.S. Treasury Market will have to make do with just a measly $300 billion from Ben Bernanke.

That was last week's message from Federal Reserve officials, who appeared to shut the door to a second round of quantitative easing. Coupled with evidence of stubborn inflation and a stabilizing economy, the message helped send bond yields soaring despite a rare supply respite.

High Inflation Still A Concern

Despite the end to Quantitative Easing, inflation is still a concern for the coming years. In a June 25 2009 Financial Times article, Alan Greenspan wrote:

Inflation is a special concern over the next decade given the pending avalanche of government debt about to be unloaded on world financial markets. The need to finance very large fiscal deficits during the coming years could lead to political pressure on central banks to print money to buy much of the newly issued debt.

Hyperinflation Violates Fed’s Mandates

Federal Reserve board members emphasize their dual mandate of balancing “price stability and maximum employment.” In reality (hat tip to David Merkel), the Fed has three mandates:

Federal Reserve's Mandates:
1. Protect the financial system in a crisis.
2. Maximum employment.
3. Price Stability (Low Inflation).

High inflation may be tolerated in order to protect the financial system and/or generate higher employment. However, hyperinflation would violate two Fed Mandates: it would create a crisis in the financial system and violate the price stability mandate of the Fed.

Hyperinflation Isn’t Coming

Due to the ballooning national debt and the unfunded liabilities of Social Security and Medicare, our nation could experience an era of high inflation. It is highly unlikely, however, that the U.S. will experience hyperinflation.

As long as the Fed remains independent, hyperinflation is highly unlikely for the following reasons:

  • Our financial problems are severe, but not so severe as to pursue the deliberate, suicidal course of hyperinflation.
  • Hyperinflation would violate two out of three of the Fed’s mandates
  • The Fed has stopped Quantitative Easing and appears concerned about overly high inflation.
  • It takes deliberate and persistent action to create and sustain hyperinflation. The Fed’s actions to date may generate high inflation, but they won’t generate hyperinflation.
  • Hyperinflation would hamper the government’s ability to do two of its favorite things: garner taxes and issue new debt. 

Despite all the pundits telling you to go out and buy gold, doomsday forecasts rarely come true. The way things stand currently, the consensus of economists is that the US will not experience a hyperinflation as occurred in the Weimar Republic or in Zimbabwe.

Full Disclosure: Author holds no position in any fund mentioned in this article. This article is the author's opinion only. The article is for informational purposes and is not meant to be construed as an invitation to invest with any specific strategy or to buy or sell any securities. You should perform your own due diligence and consult with a professional before investing.