Hyperinflationists Have it Wrong

There are undoubtedly many people in long gold positions wondering whether the old yellow dog is going to get up and bark again anytime soon. Although hyperinflation hyperventilation has been catching on in recent months, especially amongst the deficit errorists, gold has been dead money since late November 2009.

What gives? We lay it all in the June issue of The Richebacher Letter in a section titled “Weimar 2.0.” As we point out, hyperinflation requires extreme conditions not just on the demand side, but on the supply side as well.

On the demand side, in order for households’ spending power to keep up with rising prices, household nominal incomes or credit access must be ratcheted up in sync with price hikes or the price hikes will not stick. Households will have to pull back in other, less-essential spending areas to afford the same quantity of goods in essential items…

That is why hyperinflation episodes need not just fiscal deficit spending, but also some sort of escalator clauses or cost-of-living adjustment mechanisms built into wage contracts… Take that element away – and it is a recurring theme in historical episodes of hyperinflation – and households cannot keep up with hyperinflation. The higher prices cannot get validated by higher consumer spending. The hyperinflation flares out.

Beyond this demand-side component, which is scarcely to be found in the U.S. wage contracts these days, there is the supply-side issue. Productive capacity must be closed or abandoned in order for the hyperinflation to really rip…

Suffice to say that hyperinflation takes a very special set of conditions. It is not, contra Paul Krugman, all about fiscal deficits, nor is it only about fiscal deficits. That is why we do not see hyperinflation breaking out all over the place on any given day, despite the fact the governments have to first create the money that you use to pay taxes or buy Treasury bonds.

Rob Parenteau
for The Daily Reckoning