Hyperinflation or Hyperdeflation
James Turk's article Hyperinflation Looms dated April 20, 2010, is based on Quantity Theory of Money (QTM). It draws an analogy between Weimar Germany of 1923 and the United States of 2010. Both precepts are invalid. As far as the QTM is concerned, it suffices to point to the very fact, admitted by Turk, that it is possible to have a shortage of money simultaneously with the overworking of the printing presses. Hyperinflation is not the same as the ultimate inflation of the money supply. It is the ultimate depreciation of the currency unit. The two concepts are far from being the same, QTM notwithstanding.
The reason why QTM fails is that money is not one-dimensional. It is in fact two-dimensional. Quantity is one, and the velocity of circulation is the other dimension. Central banks control the former, and the market firmly controls the latter. As long as fair weather lasts, velocity may be ignored. But as soon as the weather grows foul, velocity returns with a vengeance. If it increases, we talk about inflation. If it decreases, we talk about deflation. In extreme cases, the increase in velocity may start feeding upon itself and velocity could grow beyond any limit. People buy anything they can lay their hands on because they expect prices to rise further. This is hyperinflation, wiping out the value of the currency unit. It is an irreversible process: once fiat currency loses its value, it is lost for good. The pendulum has stopped swinging. If there is a bounce, it is the dead-cat bounce.
But it is also possible that, at the other end of the spectrum, the shrinkage in the velocity of circulation refuses to stop and starts feeding upon itself. People postone buying indefinitely because they expect prices to fall further. This is hyperdeflation. It manifests itself in the ever rising value of the currency unit. It is important to remark that it can happen while some prices are still rising. Other than gold, food and energy are two important exceptions. People have to eat, and they want to keep themselves warm and mobile, no matter what. Paradoxically, this may reinforce deflation. Because of rising food and energy prices people will have that much less to spend on other goods, accelerating price declines in other sectors. This defeats the arguments of Turk and others who try to refute the case for deflation by pointing to high or rising costs of food and energy.
The point in either pathology of money is that the government is helpless. Once the point of no return is reached, there is nothing governments can do to convince people that the process will end — short of opening the Mint to gold and/or silver. As far as people are concerned, the feedback from their experience tells them to expect more of the same.
I am not trying to adjudicate between the two schools of thought, one asserting that hyperinflation and the other asserting that hyperdeflation of the dollar is inevitable and imminent. I am merely trying to point out certain facts about deflation that most people are unaware of, or tend to ignore.
Let me state first that it is not impossible for the dollar to go into hyperinflation during the next 12-month period. For example, consider the case of a shooting war between the U.S. and Iran in the Persian Gulf. After an initial euphoria the American military could start suffering setbacks on the ground, in the sea and in the air, simply because of the longer lines of communication from the home base, and also because of the disadvantage of the aggressor in face of patriotic zeal on the part of the defenders (c.f. Vietnam). In this scenario hyperinflation of the dollar could be a possible outcome. But short of war threatening to destroy supplies and producing facilities the word 'hyperinflation' rings hollow in the ear.
Post-World-War I Germany versus Post-Cold-War U.S.
To draw a parallel, as Turk does, between Weimar Germany and present-day U.S. is, to say the least, grotesquely unrealistic. In 1923 the once mighty German army was defeated and disarmed, the navy was scuttled, the territory of the country was badly truncated by the peace treaty of Versailles, the Rhineland was under military occupation while the rest of the country was still under a partial blockade. No speculator would touch the falling Reichsmark, except to short it.
By contrast, the United States in 2010 has an army, navy and air force that can be put on high alert in a matter of minutes. Its military bases pockmark the face of the globe. The over-riding fact is that the whole world is still anxious to sell its wares on the American market, and is happy to lend back to it the proceeds of the sale in order to finance future U.S. purchases. Furthermore, it is a fact that the bond market trading U.S. Treasury debt is still the largest and most liquid in the world. Significantly, it still has room to go up – thus offering speculators juicy profits at a time when the bloom is off the stock and the real estate markets. How can you compare the circumstances of a beggar with those of the emperor – prodigal and bankrupt as though the latter may be?
All the signs around us point to deflation. The money supply is being pumped up on an unprecedented scale, but all it does is push on a string. You cannot make a case, as Turk is trying to do, out of the fact that the price of crude oil doubled as compared to its recent low. Another fact, more startling, is that the price of crude oil has declined 45 percent as compared to its all-time high. We must see the general decline in world prices, even though in some cases they may be disguised as a loss of pricing power of the producers. True, list prices have not declined, but nobody trades them. They are for window-dressing only.
Obviously, you need a theory to explain what is happening other than the QTM. I have offered such a theory. I have called it the Black Hole of Zero Interest. When the Federal Reserve (the Fed) is pushing the rate of interest down to zero (insofar as it needs pushing), wholesale destruction of capital is taking place unobtrusively but none the less effectively. Deflation is the measure of wealth in the process of self-destruction — wealth gone for good. The Fed is pouring oil on the fire as it is trying to push long-term rates down after it has succeeded in pushing short term rates to zero. It merely makes more wealth self-destruct, and it makes the pull of the Black Hole irresistible.
But why is it that the inordinate money creation by the Fed is having no lasting effect on prices? It is because the Fed can create all the money it wants, but it cannot command it to flow uphill. The new money flows downhill where the fun is: to the bond market. Bond speculators are having a field day. Their bets are on the house: if they lose, the losses will be picked up by the public purse. But why does the Fed under-write the losses of the bond speculators? What we see is a gigantic Ponzi scheme. The Treasury issues the bonds by the trillions, and promises huge risk-free profits to the bond speculators in order to induce them to buy. Most speculators believe that the Treasury is not bluffing and they buy. Some may believe that the Fed is falsecarding doubts and they sell. But every time they do they only see foregone profits. What we have here is a rare symbiotic relation between the government and the speculators.
When he was forced out of business by the courts, and his customers lost everything they invested, Charles Ponzi declared that he would have paid them to the last cent as contracted if they had let him. There is no reason to doubt his sincerity. Now, 90 years later, Charles Ponzi's dream has come true. The US government is duplicating Ponzi's scheme in the bond market. The only difference is that the stake is much higher: it is the national, nay, the world economy! And, most importantly, this time there is absolutely no danger that the courts will stop the racket. The world begs to be fooled.
Posted by Alex on 06/04/10 02:22 PM
I think the article is deficient. The author clams that government can print all the money it wants but cannot force people to spend it. But this is clearly false. Of course the government can force people to spend. Bernanke himself spoke of the idea a few years ago. All you have to do is deposit in the bank account of every American sufficient money. If you deposit $1 million to every American's bank account, do you REALLY THINK they will keep it there and not cause inflation?? Ok, so the threshold is not one million, make it 2 million, 5 million, at some point if your neighbour is buying a Ferrari you are going to do it too.
So deflation is NOT POSSIBLE under this system. I can't believe people still fear it!
Posted by G Kaiser on 05/16/10 07:01 AM
The ponzi scheme is only possible because the game is rigged. The value of a currency can be controlled irrespective of what the players do. You can hoard a pile of money in a hole in the ground, but it can be rendered valueless by decree. Even more so with money in bank accounts.
There is only one known way to sidestep these issues, and that is the possession of physical assests, mainly gold. Anything else leaves control of your families future in the hands of criminals.
The current events (in especially Europe) seems to indicate that many people are starting to realise that fact. Gold has started to act as currency.
Posted by Jeff Wright on 05/15/10 04:08 PM
A comment I received from a friend, Dr. Paul Prentice, a former economist in the Reagan administration:
"A pretty good piece on the subject. However, most such analyses miss the point about interest rates. They represent much more than the return to capital, or the price of debt. At the highest level, they represent the "social rate of time preference." The reason that zero interest rates are a "black hole" is that they represent a total indifference between consumption today and consumption tomorrow. Based on basic human nature, this is impossible and can only be created by government manipulation.
Zero percent interest rates represent the ultimate disconnect between a fiat currency and real economic activity. A discount rate of zero totally erases the time component from economic calculation. In my opinion, that is the true "black hole".
Reply from The Daily Bell
Wow. Interesting analysis. Thanks for sharing.
Posted by TaxSlave on 05/15/10 03:13 PM
I enjoyed the article and the comments, as always.
Government bonds put citizens in bondage to pay them back out of future production. The sad reality is that here in the U.S., the government is not only borrowing at a rate no future increase in production can pay back, but is simultaneously destroying the very capacity for that production.
In simple terms, this translates to: Pretty soon the world will see that we can't pay those bonds off. Not only won't the government be able to roll over its short term debt, but holders of these bonds will want to be the first ones out rather than get left holding worthless paper. At present, only the prospect of mutually assured destruction along with greater distrust of their own currencies are preventing sovereign debt funds from dumping U.S. government debt. On the day when it appears destruction is inevitable (because we will never be able to pay those bonds off), the bond market will implode.
That will be the day our currency is dead, and likely others along with it. The only options will be repudiation or inflation. Or perhaps a restructuring, with the IMF running the U.S. as it does every other spendthrift country it bails out.
If anybody sees any alternative to this outcome given what has been happening, I'd like to hear it. (Brighten my day, please.)
Oh, and if you want something to cheer you up, just remember that all the schools in the land teach the widely accepted premise that World War II 'got us out of the depression', and it wouldn't surprise me in the least that our 'leaders' and those of other countries might all agree that all we need is another great war to clear things up.
Posted by Henry on 05/15/10 01:05 PM
i'd understand things better if instead of saying velocity we said hoarding or dishoarding
Posted by AmanfromMars on 05/15/10 01:02 PM
So what the Fed really needs is a champion/champions to whom they can supply free credit/ready cash, which they can spend lavishly to generate new economy with a virtual energy which will itself enable and fund/energise those areas/goods/beings on whom it is has been spent by the aforementioned champions/bank proxies/ringers/cal them what you will ....... creating a virtuous generative circle, rather than the present crazy nonsense of apparently creating vast wealth and quantitatively eased funds, to in reality buy nothing but the toxic debt and junk bonds which created their escalating problem in the first place? And that would thus be guaranteeing the swift arrival of another even more severe meltdown and/or rogue market manipulation, for as all can see, has the recent horrendously expensive trillion dollar global bailout solved and helped nothing and no one and has actually made the situation even worse, and has also highlighted the idiocy of its key players.
Does anyone know where one one signs on the dotted line as a active model champion for the System, which is in Real Serious Trouble indeed, and definitely needs novel help?
Posted by William Pickering on 05/14/10 11:51 PM
In a closed system (US EU) maybe this argument holds, but expanded worldwide it doesn't. Example, China implodes and stops buying US bonds, even has to sell them and then gold. Long US rates explode, foreclosures mushroom, production plummets and massive shortages of everything appear. Once shortages occur, the rush of money velocity accerates and a government yields to mob demands.
Posted by MetaCynic on 05/14/10 10:59 PM
I find it difficult to visualize a deflationary situation where people will continue to lend money to a central government at zero or near zero interest rates indefinitely. If, as the professor argues, such an environment is a wealth destroying black hole, then where is the capital coming from to lend to government?
What happens when the central government's debt becomes so large that the interest on that debt exceeds the government's revenue collected through taxes especially as tax generating wealth plummets? Wouldn't lenders long before then demand higher interest rates to cover the risk of sovereign default? Absent a new tax source, wouldn't this additional burden then induce the central bank to step in and monetize more of that debt? Wouldn't this latest increase in the money supply, even without the multiplier effect of the fractional reserve banking system, then cause a general price inflation as government spent this new money from the central bank?
Posted by John Of Sparta on 05/14/10 07:35 PM
Ponzi was correct.
He actually WOULD have paid...because of the supply of players.
The GAME continues to Pay as long as there are players.
when the GOV stopped the playing, the game stopped.
bottom line: as long as the Next Guy takes the bait,
the game goes on. or, as it was said to me...always leave
just a Little More profit for the next guy who buys into
your bull--it and he'll buy.
Posted by F. Beard on 05/14/10 06:16 PM
"Our instinct is to grant more credence to the quantity of money theory than Dr. Fekete does - but he has certainly made interesting and thought-provoking points, as usual. " DB
Money is one mind boggling concept. Personally, even if I was convinced I understood it completely, I would insist on allowing alternatives. Anything else is tyranny, which I will not be a party to if I can help it.
Reply from The Daily Bell
Posted by Lila Rajiva on 05/14/10 05:28 PM
I've read Antal Fekete with a great deal of interest and appreciate his explanation of the black hole of capital destruction.
However, inflationists would argue that the deflationists discount the effect of price on money velocity. That is, at some price of money (interest rate) money will indeed be loaned, even if that price is negative.
Thus they say there has never really been true deflation in the last 100 years, only asset price deflation and insidious and hidden inflation.
This argument has practical importance in trying to figure out the future movement of gold prices relative to the stock market.
If we are in a true deflationary environment, gold should follow commodities and the stock market down.
In a true inflationary environment all three should be elevated.
Do I misunderstand this, or is this roughly correct?
Reply from The Daily Bell
These are difficult arguments. We published Fekete's piece in part because he is an original thinker (and Bell commentator) and in part to inspire the sorts of discussion in which you are participating. Our instinct is to grant more credence to the quantity of money theory than Dr. Fekete does - but he has certainly made interesting and thought-provoking points, as usual.
Posted by Bill on 05/14/10 04:20 PM
One of the best articles I have read in a long time.
Posted by Huh on 05/14/10 02:17 PM
It appears to me that Fekete is assuming that people in the US are largely stupid and ignorant. Granting that assumption for now, his thesis will hold for a while until at some point the pain from the wealth redistribution will be so huge that people will start complaining.
And they will start asking questions and the internet will reveal the Cantillon effect and its enabler - the fiat paper/electronic money system. And then the people will really get what they want. If they want to be set free from their bondage, they will not want to hold on to their silly dollars any more.
Further, Fekete certainly engages in some exaggerated hyperbolic illogical claims while accusing others of doing so. For example, witness his claim that "Deflation is the measure of wealth in the process of self-destruction".
We already knew that price controls are bad, inefficient and destroy capital. I don't know why Fekete feels this is particularly true only when the Fed lowers interest rates.
Posted by Peter on 05/14/10 01:22 PM
I do not think that Dr Fekete is fully considering the damage to the productive economy caused at this late instant in this fiat cycle by misallocated currency and credit.
I think it likely that a perception of deficiency or deficiency of essential goods and services could occur and that this will drive extremely high money velocity and resultant hyperinflation particularly as the replenishment of essentials occurs over a short time period and as such is a strong catalyst to velocity and upward reprising.
I do agree that the QTM is not alone capable of explaining hyperinflation but that panic driven velocity is the prime driver.
I think it more likely that unstressed rate of money quantity increase would more likely find its way into asset class goods and that this is exactly what we have witnessed prior to 2007.
Posted by Ryan on 05/14/10 11:45 AM
When the Federal Reserve ceases paying the commercial banks to park their reserves at the Fed, and the banks begin to lend again, the banks' reserves (which have been bolstered with trillions in fiat injections) and the fractional-reserve multiplier will be the driving forces.
Also, when capital is destroyed due to a subsidized pattern of capital consumption, output declines and the existing demand competes for this declining output. The price trends upward from the non-intervention price.
Mass inflation is already baked into the cake. The only question is how bad it will be at this point. A careful reader would note that deflationists have been predicting deflation since the 60's and have been nearly consistently wrong. That is because state interventions in the market take the side of inflation, of reducing output to benefit constituent suppliers of goods and services, and increasing the quantity of money in circulation to benefit constituent consumers of goods and services.
Raising taxes is politically suicidal, so the only thing that can remove money from circulation is central bank intervention -- paying commercial banks not to lend.
Posted by Cavenon (from Portugal In Trouble) on 05/14/10 11:44 AM
Thank you very much Daily Bell for showing us important issues like this one from Prf. Fekete. This is a brilliant post, like most of the others that you put here to the world people looking for the true knowledge.
Posted by Andras on 05/14/10 11:05 AM
The only barrier to money velocity and thus hyperinflation is the printing press. The literal one. As soon as they start printing large nomination bills with ever exceeding zeros to catch up with the digital world of the shadow banking system the dollar is doomed.
With small nomination bills there is no enough paper to follow. It explains the dichotomy of talking about trillion dollar bailouts and still you can buy a hamburger for a unit. The paper based money system has material limits which keeps it intact. Even the printers can not compete with the existing stock of money in the short term.
Credit, the real measure of the digital money supply is shrinking and can not grow as the Professor explained. If the convergence of the two systems is too violent there will be separation, there will be hoarding of paper money. That is when the danger of the introduction of the large nomination bills into circulation is the highest.
Posted by F. Beard on 05/14/10 09:41 AM
A good article and informative. However I doubt velocity alone could drive hyperinflation. There is a limit to how fast one can spend his money. However, there is no limit to the amount of money/credit that can be created by a central banking system.
Posted by Jeff on 05/14/10 07:51 AM
The persians wouldn't lay down and the chinese and the russians wouldn't be happy. My president doesn't have the chuptzpah for a massive boots on the ground campaign unless i'm wrong then we can call it Obamageddon LOL. We couldn't write a better script for sci-fi the whole economic scene is a mess g-d help us.
Posted by Benjamin on 05/14/10 05:37 AM
My hat's off to the good professor. He has forever changed how I view all things about money!
But I'm not so sure that even a war could induce hyper-inflation. Not in the U.S., anyway, as we've already built up our military/industrial complex, which would account for, imv, the bulk of what hyperinflation would be used for. Since we've got all we need (and then "some"!), I just can't see hyperinflation of the USD occurring any time soon. If anything, I would think Iran (or whomever we go to war with) would have to destroy _their_ currency through hyperinflation in order to cope. But whether this was to build up their military or just to deal with economic disruption, it matters not. They would probably be defeated in short order, their money no longer any good in the market. Therefore (assuming this turns out to be correct) any war with Iran would probably a repeat of Iraq and Afghanistan. They would let us invade, with little resistence, and let insurgency drive us away over time, which is a far better alternative to needless hyperinflation (and certain defeat).
Does anyone else think so as well?
Reply from The Daily Bell
Time will tell.