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I am 100% sure that the U.S. will go into hyperinflation. Not tomorrow, but the problem with the government debt growing so much is that when the time will come and the Fed should increase interest rates, they’ll be very reluctant to do so and so inflation will start to accelerate.
-Marc Faber, Bloomberg, May 2009
During the world’s last inflationary period in the 1970s, the West witnessed social unrest of the most acute kind, bordering at times on anarchy. If stagflation can lead to anarchy, hyperinflation can lead to and has led to much worse. Hyperinflation is the economic apocalypse many doomsdayers pose as the logical end to the world’s experiment with fiat money.
In a letter to clients last June, Rob Parenteau of the Richebacher Letter wrote about Weimar, one of the worst episodes of hyperinflation:
"The Weimar Republic, born of a revolution in 1918, played host to a hyperinflationary breakdown of the German monetary system by 1923. Austria faced a similar episode of hyperinflation in 1921"“2, and no doubt, the searing scars of these experiences deeply informed the thinking of Mises, Hayek, Haberler, Machlup and other leading contributors to the Austrian School in the 20th century.
"Hyperinflation episodes are characterized by rapidly accelerating inflation, a collapsing foreign exchange rate and, eventually, a widespread disorientation and disruption of productive activity. Keynes, writing in 1919, well before the terminal stages of the Weimar hyperinflation had been revealed, characterized the nature of the mayhem involved in such episodes as follows:
"As the inflation proceeds, and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery."
Is this what awaits the US or the UK? Marc Faber’s quote to open this post is symptomatic of the kind of rhetoric which says yes. I love Marc Faber. I consider his interviews first-class economic entertainment. You will continue to see him featured in my posts on a regular basis. And I certainly share some of his concerns about inflation, bailouts, moral hazard (and so forth and so on, as he would say).
But, is Marc Faber an ideologue pushing a rhetorical line of argument to the point of hyperbole or should we take his warnings very seriously?
Let’s attack this question using Zimbabwe and Weimar Germany as examples. These are the two most extreme cases of hyperinflation that economic historians have ever witnessed. They are instructive in regards to what causes hyperinflation and what does not.
Weimar Germany 1919-1923
After World War I, every nation which fought was broke because of the war’s cost. No country had enough gold assets to repay the billions of dollars they owed. And this was a multilateral problem. For example, Britain could not repay its debts to the US until the other Allies repaid their debts to Britain. The Americans were not sympathetic. The prevailing desire was recovering the over $25.5 billion the US had loaned to other nations during the war.
As a result of these debts, the war’s victors laid out draconian terms to punish the Germans in the Treaty of Versailles in 1919. War reparations were one third of Germany’s spending. Therefore, Germany’s budget deficit was half of GDP. (The situation in Iceland due to Icesave’s collapse comes to mind here). And to make things even worse, reparations were in a foreign currency.
It’s not as if the Germans could print off a bunch of Reichmarks to make good on their reparations. When the Germans defaulted on their obligations, the Belgians and the French moved in and occupied the Ruhr region, Germany’s industrial heartland. The result was widespread strikes and idled productive capacity. Afterwards, demand for goods in Germany far outstripped the productive supply.
So, with a huge portion of tax revenue going to pay reparations in foreign currency, the German government turned to the printing presses to make good on its domestic obligations. The surge in money supply and the lack of productive resources led to hyperinflation and collapse.
The key to Weimar’s hyperinflation was two-fold.
That’s Weimar.
Zimbabwe
While the facts in Zimbabwe are different, the underlying causes for hyperinflation were the same: foreign currency obligations and a loss of productive capacity.
Zimbabwe had established Independence from Britain in 1980. Yet, by the late 1990s 70% of productive arable land was still held by the small minority 1% of white farmers in the country. After years of talk about redistribution, in 2000, the President Robert Mugabe began to redistribute this land.
The redistribution process was a disaster, both legally and economically. Many whites fled as violence escalated. The result was an enormous decline in Zimbabwe’s agricultural production. With agricultural production having plummeted, Zimbabwe was forced to pay to import food in hard currency.
Meanwhile, the government turned to the printing presses to fulfil its domestic obligations. as in Germany, the foreign currency obligations, the loss of productive capacity and the money printing was a toxic brew which ended in hyperinflation.
Hyperinflation in the UK or USA?
So, that’s a brief outline of what happened in the two most notorious cases of hyperinflation. Notice that in each case you had an enormous foreign currency obligation and a massive loss in productive capacity. The U.S. has not suffered this kind of loss. In fact, productive capacity swamps demand for goods in the U.S. And, as the embedded presentation on hyperinflation from Marshall Auerback shows, the fiscal deficits in the U.S. are a far cry from the 50% of Weimar.
Will the US turn into a modern day Weimar Germany?
Marshall talks about this using an MMT framework. But, his three most compelling slides on pages 4 to 6 don’t depend on MMT. They simply demonstrate that without pricing power or a large fiscal deficit and large foreign currency demands, talk of hyperinflation is misguided. Crucially, Marshall writes:
Inflation is ultimately about competing distributive claims over real resources. The main limitation then, or rather the determinant of the limits of a “sustainable” fiscal policy, especially with respect to hyperinflationary risks, have to do with real resource constraints, not “running out of money” or absence of government financing, for countries possessing sovereign currencies.
The inability to tax and dependency on foreign currency are central to hyperinflation or national solvency. Moreover, in Zimbabwe and Weimar, it was the trashing of productive supply that created inflation (think supply versus demand).
Ideology
So, that’s the economics. What about the ideology? Well, the MMT’ers say that the Austrians ideologues and the gold fetishists have a deflationary bias when inflation doesn’t change the real productive capacity of a nation. Clearly, the hyperinflation talk is a gimmick with which to discourage deficit spending. You should see this debate as about a specific policy prescription driven by ideology. The other side of this ideological divide was taken up by Dean Baker in the Guardian’s “Cliches won’t fix the financial crisis“
Nevertheless, inflation does alter business decision-making via accounting’s tie to nominal numbers and the money illusion. Moreover, inflation reduces relative wealth by transferring income from those who receive the money first like banks versus those who receive their money later, your typical widow living on fixed income bonds and annuities. Finally, inflation encourages the accumulation of debt by benefitting borrowers over savers. I see inflation as a problem to be avoided.
Ideologically then, I see inflation as the increase in the money supply.
Economics. an increase in the VOLUME of money, which eventually leads to a persistent, substantial rise in the general level of prices and results in the loss of value of currency.
-What is Inflation?, Credit Writedowns, June 2008
And where inflating the money supply does not eventually lead to consumer price increases, it does lead to asset price increases which foster a stronger boom-bust tendency.
So, people like me look at large government deficits in a fiat currency system as an invitation to print money and inflate the money supply. If you take this way of thinking to a logical extreme, you end up with what Marc Faber is talking about: hyper-inflation.
But, this is ideology "“ not economics. The claims of hyperinflation awaiting the US or the UK seem hyperbole at best, misinformation and deception at worst. Hyper-inflation has very specific pre-conditions in foreign currency obligations and a loss of tax revenue and productive resources. ‘Printing money’ alone doesn’t get you there. So, it simply isn’t credible to claim that Hyperinflation in the US or the UK is in the offing now or anytime in the immediate future.
As for Anarchy in the UK, that’s another matter.
Cue the Music.
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Print This Post sr_adspace_id = 5672807; sr_adspace_width = 468; sr_adspace_height = 60; sr_ad_new_window = true; sr_adspace_type = "graphic"; Category: Economics Tags: central banks, financial history, inflation, Marc Faber, money« Markets Give Thumbs Down on Greece Aid «» Deflationary Forces in the US and Loan Officer Survey » David PearsonEd,I think the Weimar/Zimbawe analogy is a red herring.In Latin America, dozens of currencies have been abandoned after episodes of hyperinflation. New pesos, australs, new australs, cruzeiros, cruzados -- you get the picture. There is plenty of experience there to mine without resorting to economies devastated by war.Latin America teaches us that hyperinflation is simply the process of eroding confidence in a currency. Nothing magical or exceptional about it. In no case did a government set out to hyperinflate. In fact, a precondition of hyperinflation by a rational government is that people believe hyperinflation is near-impossible. That is, governments depend on "money illusion" when they print money to pay for goods and services; that "money illusion" in turn depends on anchored inflation expectations. So when I hear people say, "it can't happen here," I hear the basic requirement for a government to set on course towards debasing the currency.The counter-argument against the Latin analogy is always that their debt was issued in foreign currency. This is essentially a call on the character of inflation expectations on the part of debt holders. Magically, the local currency debt holders of U.S. debt are thought to have highly anchored inflation expectations: boundless "money illusion", such that they are willing to hold U.S. debt in the presence of any degree of deficit monetization. I'm not saying this view is necessarily wrong: just that its proponents, to my knowledge, provide little or no evidence for holding it. Marshall AuerbackThe Latin American analogy is totally inapplicable. Argentina adopted a rigid peg of the peso to the dollar and guaranteed convertibility under this arrangement. That is, the central bank stood by to convert pesos into dollars at the hard peg. They didn't operate under a monetary regime like the US. The choice was nonsensical from the outset and totally unsuited to the nation's trade and production structure. In the same way that most of the EMU countries do not share anything like the characteristics that would suggest an optimal currency area, Argentina never looked like a member of an optimal US-dollar area. For a start the type of external shocks its economy faced were different to those that the US had to deal with. The US predominantly traded with countries whose own currencies fluctuated in line with the US dollar. Given its relative closedness and a large non-traded goods sector, the US economy could thus benefit from nominal exchange rate swings and use them to balance the relative price of tradables and non-tradables. Argentina was a very open economy with a small non-tradables domestic sector. So it took the brunt of terms of trade swings that made domestic policy management very difficult. Convertibility was also the idea of the major international organisations such as the IMF as a way of disciplining domestic policy. While Argentina had suffered from high inflation in the 1980s, the correct solution was not to impose a currency board. The currency board arrangement effectively hamstrung monetary and fiscal policy. The central bank could only issue pesos if they were backed by US dollars (with a tiny, meaningless tolerance range allowed). So dollars had to be earned through net exports which would then allow the domestic policy to expand. After they introduced the currency board, the conservatives followed it up with widescale privatisation, cuts to social security, and deregulation of the financial sector. All the usual suspects that accompany loss of currency sovereignty and handing over the riches of the nation to foreigners. The Mexican (Tequila) crisis of 1995 first tested the veracity of the system. Bank deposits fell by 20 per cent in a matter of weeks and the government responded with even further financial market deregulation (sale of state banks etc) These reforms loaded more foreign-currency denominated debt onto the Argentine economy and meant it had to keep expanding net exports to pay for it. However, things started to come unstuck in the late 1990s as export markets started to decline and the peso became seriously over-valued (as the US dollar strengthened) with subsequent loss of competitiveness in the export markets. Lumbered with so much foreign-currency sovereign debt the decline in the real exchange rate (competitiveness) was lethal. The domestic economy by the late 1990s was mired in recession and high unemployment. And then the "Greek scenario" unfolded. Yields on sovereign debt rose as bond markets started to panic "“ a vicious cycle quickly became embedded. In 2000, the government tried to implement a fiscal austerity plan (tax increases) to appease the bond markets "“ imposing this on an already decimated domestic economy. The idiots believed the rhetoric from the IMF and others that this would reinvigorate capital inflow and ease the external imbalance. But for observers, such as yours truly, it was only a matter of time before the convertibility system would collapse. Why would anyone want to invest in a place mired in recession and unlikely to be able to pay back loans in US dollars anyway? In December 2000, an IMF bailout package was negotiated but further austerity was imposed. No capital inflow increase was observed. Duh! The government was also pushed into announcing that it would peg against both the US dollar and the Euro once the two achieved parity "“ that is, they would guarantee convertibility in both currencies. This was total madness. Economic growth continued to decline and the foreign debts piled up. The government (April 2001) forced local banks to buy bonds (they changed prudential regulation rules to allow them to use the bonds to satisfy liquidity rules). This further exposed the local banks to the foreign-debt problem. The bank run started in late 2001 "“ with the oil bank deposits being the first which led to the freeze on cash withdrawals in December 2001 and the collapse of the payments system. The riots in December 2001 brought home to the Government the folly of their strategy. In early 2002, they defaulted on government debt and trashed the currency board. US dollar-denominated financial contracts were forceably converted in into peso-denominated contracts and terms renegotiated with respect to maturities etc. This default has been largely successful. Initially, FDI dried up completely when the default was announced. However, the Argentine government could not service the debt as its foreign currency reserves were gone and realised, to their credit, that borrowing from the International Monetary Fund (IMF) would have required an austerity package that would have precipipated revolution. As it was riots broke out as citizens struggled to feed their children. Despite stringent criticism from the World's financial power brokers (including the International Monetary Fund), the Argentine government refused to back down and in 2005 completed a deal whereby around 75 per cent of the defaulted bonds were swapped for others of much lower value with longer maturities. The crisis was engendered by faulty (neo-liberal policy) in the 1990s "“ the currency board and convertibility. This faulty policy decision ultimately led to a social and economic crisis that could not be resolved while it maintained the currency board. However, as soon as Argentina abandoned the currency board, it met the first conditions for gaining policy independence: its exchange rate was no longer tied to the dollar's performance; its fiscal policy was no longer held hostage to the quantity of dollars the government could accumulate; and its domestic interest rate came under control of its central bank. At the time of the 2001 crisis, the government realised it had to adopt a domestically-oriented growth strategy. One of the first policy initiatives taken by newly elected President Kirchner was a massive job creation program that guaranteed employment for poor heads of households. Within four months, the Plan Jefes y Jefas de Hogar (Head of Households Plan) had created jobs for 2 million participants which was around 13 per cent of the labour force. This not only helped to quell social unrest by providing income to Argentina's poorest families, but it also put the economy on the road to recovery. Conservative estimates of the multiplier effect of the increased spending by Jefes workers are that it added a boost of more than 2.5 per cent of GDP. In addition, the program provided needed services and new public infrastructure that encouraged additional private sector spending. Without the flexibility provided by a sovereign, floating, currency, the government would not have been able to promise such a job guarantee. Argentina demonstrated something that the World's financial masters didn't want anyone to know about. That a country with huge foreign debt obligations can default successfully and enjoy renewed fortune based on domestic employment growth strategies and more inclusive welfare policies without an IMF austerity program being needed. The clear lesson is that sovereign governments are not necessarily at the hostage of global financial markets. They can steer a strong recovery path based on domestically-orientated policies "“ such as the introduction of a _Job Guarantee_ (http://e1.newcastle.edu.au/coffee/job_guarantee...) "“ which directly benefit the population by insulating the most disadvantaged workers from the devastation that recession brings. However, the other lesson that Rogoff and his ilk don't emphasise "“ is that pegging a currency to another, guaranteeing convertibility and then allowing the financial sector to "dollarise" your economy (drown it in foreign currency-denominated debt) "“ is a sure way to force the country into financial ruin. It has nothing to do with the volume of public debt issued in the local currency by a government which has sovereignty in that currency. In a message dated 5/4/2010 15:03:42 Mountain Daylight Time, writes: gnkCongratulations. You have intelligently fooled yourself about fiat money. There is one more element to fiat money - and that's trust. Not just trust here in the US, but trust abroad. Especially those pesky countries that export resources - you know, tangible stuff that governments can't create out of thin air. marketseerIn the inflation/deflation debate there seems to be large confusion on currency and money. I think this is very important to understand the entire inflation deflation debate. It reminds me of Jon Externs inverse pyramid except only as it relates to M0 through M4. It seems to me (my thoughts) if the system is delevering you have to have a more squarish pyramid to create true inflation. The pointier the pyramid the harder it is to create true inflation. The reason is because the point above gold (cash or M0) is so much smaller to the base of the pyramid (in this case top of the inverse pyramid) that if the system is deleveging it can't keep the surface area of the total space from shrinking. The Wiemar Republic created a fairly wide base where the entire monetary system was essentially M0. Money printing than increased inflation essentially 1 for 1. We would have to create billions/trillions of M0 to get inflation in our current system. The notional value of outstanding over the counter derivatives in June 2009 (the latest number) was 604 trillion (market value was 25 trillion) down from 683 trillion in June of 2008. When you have this sort of deleverging, assuming it continues you are not going to get inflation. You can get asset bubbles that look like inflation but the risk of deflation is still massive until the top of the pyramid shrinks to a proportion where crises won't shrink the the surface area of the entire inverse pyramid. If the wrong thing happens we would have massive deleverging and deflation tomorrow. I could be wrong but it sure seems M0 size in relation to M4 plays a huge factor which I have not seen discussed anywhere. haris0710 year JGB at such low rates is also a real good example of this. So, ok, no hyper inflation in the US...agreed. MMT is an elegant theoretical concept yet is practically useless in trying to fix the problems. Ok, no hyper inflation, great, lets opt for Japan style 20 year no economic growth - Koo argues that this is the best they could have done, but is it? Other MMT proponents say, just print money and hand it out - ok, but as Edward has pointed out and I tend to agree, this will only lead to more malinvestment and yet another asset boom and bust. Furthermore, as long as the citizens of a country begin perceiving this as the "solution" to all their problems, they will just not bother working productively...why bother, pile on debt, live off asset bubbles where value does not depend on future cash flows but a ponzi like mechanism and when sh%^ hits the fan, govt will bail us out. This will lead to sloth and eventual decay of the society.What MMT proponents fail to realize is that economic growth, or sustainable economic growth, has to come from productive assets becoming better and better at productive capacity (whether it is capital or labor productivity) and hence increase future cash flows. Just handing out some $ or some â?¬ will lead to malinvestment, asset bubbles, sloth and decay of the country. Even if it isn't hyperinflation per se, that doesn't sound like a good story at all!Some MMT ideas coupled with some debt destruction (Austrain-Keynesian approach) seems to be the way forward....have to inflict pain on folks who borrowed too much to teach them a lesson so as to not take rising asset prices for granted in a ponzi like economy, but sterlizie the pain by keeping some social contracts such as a jobs program or a tax benefit/credit, unemployment etc. W/o any Keynesian backstop, rising unemployment and real hardships from destruction of debt can and probably will lead to social disturbances and anarchy. Edward HarrisonMarc Chandler's latest (the post after this one) shows that DE-flation is what is the near term risk. And this should make sense given high debt levels, high unemployment and relatively low capacity utilization rates. It doesn't make a whole lot of sense to worry excessively about inflation when deflation is breathing down our neck.In any event, my thinking is still along the lines of this post from last year:http://www.creditwritedowns.com/2009/06/central...We will see only cyclical bouts of inflation i.e. inflation that is not embedded and therefore not persistent. Warren Mosler says this isn't inflation, which is embedded and persistent price pressure - a very different definition than I gave above. We both agree, however, that the deflationary forces of excess labor, capacity and debt are dominant. JackI think there is a tendency to misuse the word hyperinflation in a lot of conversation. Most often high inflation is meant instead. We won't have to worry too much about inflation while the private sector is deleveraging I don't think. cswakeThe one certain outcome from the period of worldwide floating exchange rate systems for all major currencies is that it will be unprecedented in scope and nature.If you follow Faber's interviews, he has at least once provided that his caveat for the hyperinflation scenario is history's evidence that politicians prefer inflation to outright default. I believe that anyone on this blog will agree that most politicians in the western countries will follow the path of perpetual increases in debt, and that the only question is how the world and the respective countries change once that ultimate debt-collapse is reached.In the case of the U.S., there are two counterarguments I see to your comments about debt burden as a % of GDP and the productive capacity. First, combine the the U.S. debt burden with the interest rates of the 1980s and you'll have interest payments alone that constitute 20% of GDP. (Assuming 14 trillion GDP/14 trillion Debt) This of course doesn't count all the explicit and contingent liabilities from the entitlements, bailouts, and wars that will probably help to make the fiscal deficits even larger. The drop-off in GDP due to such rates would also be an interesting side-effect that would exacerbate the situation. Second, the U.S. productive capacity in output has been increasing, but the composition has changed dramatically over the past several decades. Last I recall, about 60% of our manufacturing was in heavy industrial goods (cars, trains, construction equipment), technological components, and health care equipment.If the U.S. decides to print rather than raise rates, and foreign creditors demand payment in their own currency, the external cost of many of our essential goods, including oil, will go through the roof, and retooling our manufacturing base will take a LONG time in those circumstances. The real analysis needs to look at if the Federal Reserve would even consider raising rates to 20%, or higher, and the consequences to the world's greatest debtor nation. I believe they won't since consumption would just stop and our country would have to face the music. The politicians will print and to what levels of hyperinflation it leads us to is another interesting analysis - I do not believe it'll be on the same levels as Weimar or Zimbabwe just because the U.S. still is productive. (I've seen varying definitions of hyperinflation, btw) I do believe the sudden transition away from the USD as the reserve currency will be tough for the entire world.blog comments powered by Disqus var disqus_url = 'http://www.creditwritedowns.com/2010/05/mmt-hyperinflation-in-the-usa.html '; var disqus_container_id = 'disqus_thread'; var facebookXdReceiverPath = 'http://www.creditwritedowns.com/wp-content/plugins/disqus-comment-system/xd_receiver.htm'; var DsqLocal = { 'trackbacks': [ ], 'trackback_url': 'http://www.creditwritedowns.com/2010/05/mmt-hyperinflation-in-the-usa.html/trackback' }; /**/ Subscribe SearchLijit Search sr_adspace_id = 3985607; sr_adspace_width = 300; sr_adspace_height = 250; sr_ad_new_window = true; sr_adspace_type = "graphic"; About the authorRandom Quote“Our financial institutions are strong. Our investment banks are strong. Our banks are strong. They're going to be strong for many, many years.”-- U.S. Treasury Secretary Hank Paulson, Mar. 2008 CNN PollsWill Greece default?
Yes, but they will stay in the euro-zone after a managed restructuring (39%, 246 Votes)Yes and it will be a messy involuntary default (26%, 164 Votes)Yes and they will leave the euro-zone (19%, 123 Votes)No, they will take the necessary austerity measures plus receive enough support from the EU and IMF. (16%, 101 Votes)Total Voters: 634
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