2011 June 07 Tuesday
Credible Risk Of Hyperinflation?
Given the US government's $61.6 trillion in unfunded liabilities one naturally wonders how the US government will deal with mounting debts and rising demands on its tax revenues. Higher taxes? Huge cuts in benefits? Or high inflation? Given the popular opposition to both higher taxes and less benefits hyperinflation begins to look plausible. The willingness of Ben Bernanke and the US Federal Reserve to resort to "quantitative easing" (create cash out of thin air and use it to buy hundreds of billions of debt) seems to show some willingness to opt for inflation as a policy tool. Some commentators call for inflation to allow escape from debt. So is hyperinflation in the cards?
Well, in a long post Mish Shedlock argues the predictors of hyperinflation fail to appreciate the size of the financial interests arrayed against high inflation.
Please note that banks do not want hyperinflation or even massive inflation. The reason is simple: Banks will not want to be paid back with cheaper dollars, especially worthless dollars, and Congress is beholden to itself and the banks.
Hyperinflation could theoretically come from massive sustained political will to bail out the little guy at the expense of the banks, the wealthy, and the political class. However, unlike Mugabe and Zimbabwe, neither the banks nor the Fed nor the political class wants to bail out the poor at the expense of the wealthy.
Indeed, Bernanke's, Paulson's, and Geithner's actions to date have done the exact opposite!
We have bailed out the banks at the expense of the ordinary taxpayer (keeping the little guy in debt).
This is what it comes down to: In theory, Congress can easily cause hyperinflation. In practice, they won't, and neither will the Fed. As Yogi Berra once quipped "In theory there is no difference between theory and practice. In practice, there is."
So does big money oppose hyperinflation? I am uncertain and welcome any insights into how the balance of interests will develop with regard to inflation. I see the US government's financial situation as more dire than mainstream projections would lead one to expect. Peak Oil is near and will prevent the economic growth needed to pay off debts and entitlements promises. So the pressure to escape financial obligations will grow much larger. How will that pressure be relieved?
In some nations (e.g. Argentina) the financial balance of power within government is still too weak against inflation. In Argentina the government flagrantly lies about the inflation rate.
The government’s official 10.9 percent inflation rate is less than half the estimate of private economists and firms like Ecolatina, which put inflation at 26.6 percent in a report last month. The official 12 percent number for poverty is also well below independent estimates of about 30 percent.
Economists in Argentina get fined for telling the truth.
All nine Argentine economy watchers dinged with hefty fines of about $120,000 (U.S.) apiece said inflation is well above official estimates.
John Williams of ShadowStats on his web site publishes results from older methods the US government used to use to measure of inflation and he argues the US government is under-reporting inflation. Williams is predicting hyperinflationary depression. Is he right? Or will we have a deflationary depression as Nicole Foss (Stoneleigh) predicts?
Update: Ron Paul expects default by loss of value in the currency. i.e. inflation.
Al Hunt: Your speaker John Boehner says he will absolutely insist on a dollar of spending reduction for every dollar the debt ceiling goes up. Do you take that seriously?
Ron Paul: I don't take that seriously. President Reagan wanted 2 dollars of cuts. The deficit exploded. Do you think the American people will believe that we are going to cut in the future? The only budget that counts is this year. 10-year programs are pie-in-the-sky talking. This year our obligations are 5 trillion dollars.
Al Hunt: The idea of a spending cap that takes place in 10 years does not appeal to you?
Ron Paul: A 10-year spending cap is too little, too late. No one is going to believe it. All governments when they get this far into debt, default. They don't default by not paying the bills. We will always pay the bills. The default comes from the devaluation of the currency.
If you do not think inflation will become a major tool for the US government to escape from debt then how else do you think the US government will deal with the problem? High taxes? Huge slashes thru spending programs? The size of the needed adjustment is unavoidably very large. But what form will it take? This question going to be one of the biggest political battles of the next 20 years.
Well our unofficial inflation(using 1970s algorithms) rate has been around 20% over the last 3 years so it's pretty clear our government no longer reports inflation correctly.
Hyper inflation is generally the result of the loss of confidence in the government itself or massive external devaluation if linked tightly to commodities via export or import. It's not caused by printing money as much as people deciding the government is doomed. So on that basis it's very possible to have a hyper-inflationary collapse, but it's pretty much impossible to predict it. I would honestly separate hyper-inflation discussions from regular 20% a year inflation discussions as they are completely different things with separate causes.
It would be difficult to see true hyperinflation (double digits per month or more is my rough definition) of the dollar. Look at the outstanding monetary base and consider just how much money would have to be added in order to achieve hyperinflation. $Trillions per month, ballpark estimate. Or to put it another way: while they *could* print that much, why would they need to?
However, 15-20% per year real inflation seems possible and IMO likely. Yes, it screws the banks, but only to the extent that they are still holding plain old debt. If they've bundled up their mortgages and sold them to retirees or pension funds, then bought TIPS... or something else... maybe their incentives are not so clear. Don't forget, too, that banks are holding about a million houses that they would like to unload. And higher house prices would ease any default/foreclosure risks that they have remaining.
On the government side, inflation accompanied by lying about the true number allows for a politically easy solution to the problems of Social Security. Plus it helps the Feds that they are the conduit through which most of the new money enters the system.
@red: if people decide the government is doomed, does that somehow cause extra zeroes to sprout on the currency? I'm not disputing that such beliefs could be part of a chain of events leading to hyperinflation, but at some point someone does in fact need to decide that firing up the printing presses is the right course of action.
I second bbartlog's comment. We need to be prepared to respond to that. While holding cash during inflation is typically not recommended, I recall during our last bout of it back in the early 80's the yield curve was massively inverted making money-market funds tremendous investments. Equities, on the other hand, remained suppressed until inflation was tamed.
Okay, fine, you doubt we'll see double digit inflation per month. But will the government embrace inflation at all?
Do you think the US government will try to lighten its load of unfunded liabilities by inflating some of them away?
Or will the US government embrace inflation as a tool to reduce the number of underwater mortgages?
Will the US government try to create even 6-7-8% inflation to help those who owe?
Why Mish is wrong:
1) Mish assumes that banks own a bunch of loans and make money collecting interest. He lives in the stone age. It's 2011, not 1941. After Glass Steagall was repealed in 1999, banks began making money hand over fist on the investment banking side of things. They made money on mergers and acquisitions, asset management, etc.
2) He's arguing against 3,000 years of history. There's a reason the Romans made debasing coinage a capital offense. This has been going on for some time now.
3) Mish sells a low-risk absolute return fund (Sitka Pacific). In order to beat inflation, one must make some risky moves. Mish is too emotionally and financially invested in deflation to think clearly.
Yes, my reaction is similar. Many countries have debased their currencies many times for centuries. What makes America immune?
I'm not saying he's wrong. Maybe the alignment of interests is so strongly against high inflation that it is not possible. Even in America prices doubled from 1970 to 1980 and for a couple of quarters in 1974 inflation went over 12%. Have we changed that much?
The pressure to do something about the US debt build-up and unfunded liabilities will become immense as the economy continues to falter. How is this going to be resolved? I really want to know.
I imagine it will be resolved in the same manner that Germany resolved it's debt crisis in the 1930s. China is not in a position to seize America's assets - yet...