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Try This Yield Conundrum On For Size

For those convinced runaway inflation is imminent, a simple question: How do you explain Roosevelt and World War II?

There is so much to explore with this hyperinflation debate. I intentionally began by challenging a piece of common wisdom -- the notion that fiat currencies have zero value -- to try to open your eyes and stir the pot a little.

I think it worked...

I never said hyperinflation was impossible, of course. Few things are flat-out impossible. It's just not bloody likely, for reasons of historical precedent. And even if we come to that juncture, it may well take years (for reasons we shall eventually explore)...

And man, speaking of historical precedent -- wow. This is such a rich and deep topic!

There is a substantial amount of ground to cover. In due time, we'll take a closer look at the 1970s and how that big inflationary ball got rolling. We'll take a closer look at the modern Germany of today, and then the Weimar Republic Germany of the 1920s -- the granddaddy of all hyperinflation cases. And that's just for starters.

Just a Commodity?

A number of you wrote in to remind me that money (i.e. fiat currency) is a fungible commodity like any other.

But is money "just" a commodity, subject to plain-vanilla laws of supply and demand? How about gold? Or crude oil?

I think that whole debate -- whether such and such is "just a commodity" or something more -- misses an important broader point. Few relationships, even those governing basic commodities, stay simple and straightforward when geopolitics and human necessity get involved.

As you know, we are willing to fight wars over crude oil. One day (who knows) there may be wars fought over grain. In light of those two factors, the United States is still the premier military superpower by a wide margin, and one of the top grain exporters in the world. Do these factors have a subtle but tangible long-run impact on the globally perceived value of a currency? You bet they do. (More on this another time.)

Again, I am not trying to be a cheerleader for the U.S. dollar here. Nor am I trying to rule out the case for severe inflation (or hyperinflation) entirely. We could still see severe inflation, in due time, and there is a powerful case for investing in gold no matter what we see.

No, the goal here -- as we roll up our sleeves and get digging -- is to convince those of you who see the issue in black and white that it ain't just black and white. There are shades of gray... and they aren't just feverish hallucinations on the part of yours truly.

(By the way, you should hear what my fellow editor Adam Lass has to say about commodities. Sign up for Taipan Daily to read his investment commentary.)

FDR, Big Spender?

Here is another bit of food for thought.

There is a lot of debate as to who, or what, finally ended the Great Depression of the 1930s. Some argue that FDR (Franklin Delano Roosevelt) saved the country with his aggressive "New Deal" programs. Others believe that FDR was a catastrophe and a failure, and that only the kick-start of World War II finally got us out of the muck.

In July of last year, via a piece titled "What Really Brought Us Out of the Great Depression?" your humble editor proffered the following:

Here is a statistic that will make you blink. According to journalist-historian William Greider, personal savings levels hit a whopping 25% of income in 1943 and 1944.

World War II played a clear role. As Greider writes, "with so many millions conscripted for war, unemployment vanished and scarcity became the problem." Those who were not drawn into the WWII effort saw their income levels rise. Women saw as much demand as men, a new development for the times. And because the country was on a war footing, a sort of forced saving effort was in place. Families had to make do on an "austerity budget," and wound up banking much of what they earned.

This huge build-up of savings -- 25 cents out of every dollar earned -- set the stage for an explosion of consumption in the years to follow. After the war, an era of new products came rushing in. And consumers had both the pent-up savings and pent-up desire to spend, spend, spend.

So what does history have to say about our current predicament? Mainly that, when it comes to getting an economy back on track, there is little that the government can do (case in point Japan)...

As the July article concludes, "for now and the foreseeable future, we've got a hell of a lot of saving to do."

But the need for America to save -- a "duh" at this point -- is not the interesting part as far as the great hyperinflation debate goes.

Instead, here are the curious questions to ask:

  • Wasn't FDR a classic "big spender?"
  • Wouldn't all that New Deal spending have counted as inflationary?
  • Wouldn't all that WWII spending have counted as inflationary times two?

You would think so. Wouldn't you? As The Freeman observes (emphasis mine),

FDR and his advisers, despite some early moves to cut spending and control the deficit that Hoover left behind, decided that ever-larger federal spending would trigger economic expansion and pull the country out of its economic slump... The national debt more than doubled in Roosevelt's first two terms...

And we know how massive the war effort was. So, yeah. Huge-spending administration pushing on a string, followed up by monster bucks for the military machine... that should be inflationary, no?

But have a look at this gigantic chart of 10-year U.S. Treasury yields going back to 1790, via Doug Kass and Global Financial Data.

In the depths of the Great Depression, when FDR was rolling up his sleeves and doing all that spending that didn't amount to much, the yield on the U.S. 10-year was below 4%. (Kind of like now, where it's been since 2007.)

But here is the crazy thing. After the FDR binge, bond yields just kept falling.

Fifteen years later, as World War II ended... AFTER the deluge of war spending and FDR's doubling of the deficit... the 10-year yield was cut in half, below 2%!

In fact, as evidenced by the chart, it arguably took 30 years after the Great Depression -- and 20 years after the war -- for inflation concerns to truly heat up.

To quote Blazing Saddles, "What in the wide, wide world of sports is a' goin' on here?"

How does one explain the fact that massively inflationary "guns and butter" acts on the part of government have the potential to only show up with a 20- to 30-year lag... or possibly not at all? (Would inflation have kicked off even in the late '60s, if not for LBJ?)

There are answers here. They just aren't simple ones. I told you it was a Rubik's Cube...

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