Hyperinflation: Inflationists Respond

Mike Shedlock addresses articles by Hyperinflation advocates Robert Blumen and David Petch that attempt to show where deflationists get it wrong, and he explains what is wrong with their arguments.

Inflationists Respond

First, let me thank those responding to the “deflation debate.” Robert Blumen wrote an article entitled “End Game: Hyperinflation,” published in the Mises Economics Blog on July 9, and David Petch wrote “Diatribes of a Deflationist……..Why They Are Wrong” on July 13. I was hoping for a reply from Puplava, but if one was made, I did not see it.

Without addressing my blogs specifically, Blumen has this to say:

“The most obvious error in many deflationist writings is to point to the large amount of debt and stop there. All of us agree that the debt levels are unsustainable, but there are two ways of getting rid of debt: default or inflation. A cascading chain of cross-defaults would be the deflation outcome, but this is by no means assured. Historically, there have been far more hyperinflations than deflations. Debt can be inflated away.”

I am not sure who Blumen is referring to, but I laid out a concise, multipoint discussion that included the debt overhang but certainly did not stop there. Furthermore, I agree that debt can be inflated away, and I’ve even stated how: The Fed prints money like mad, and Congress gives money away at the expense of creditors, to the benefit of debtors.

Blumen goes on to say, “Another deflationist argument is that wage competition from China is deflationary and that inflation cannot occur in the United States as long as there is wage competition.”

Again, that is not my position. I did not say inflation cannot occur as long as there is wage competition. However, I most assuredly did stress that wage competition makes it much harder for inflation to take hold. There is a big difference between those statements, and it is much easier to attack a straw man than the actual arguments.

Blumen also writes:

“Another similar argument is that price increases cannot occur in the United States for goods manufactured in China. China will always offer these goods at lower prices than they can be produced in the United States, thus causing ‘deflation.’ This is also wrong for the same reasons cited above concerning nominal and real prices.”

I guess it would be helpful to see some direct quotes from articles about who is saying what. I sure did not say that. Who did? That said, given 20-to-1 wage differentials and the incomplete outsourcing cycle, there are indeed wage pressures, and those wage pressures are indeed deflationary. Again, that does not mean price increases cannot occur, but wage differentials can and have made up for huge increases in commodity prices.

The Blumen article quotes Marc Faber’s position on the U.S. dollar and gold. Faber writes:

“The question here is, what would the dollar sell off against, and what would investors perceive as a safe haven in such a situation? The euro? Not very likely! Asian currencies? Possibly, but if China were to weaken simultaneously with the U.S. economy, it’s unlikely that Asian currencies would be viewed as a safe haven. I suppose that in a crisis of confidence arising from an economic or financial problem in the United States of a scale that would lead the Fed to print money in massive quantities, only gold, silver, and platinum would be regarded as truly safe currencies notwithstanding their current weakness.”

Not sure about platinum, but otherwise, I mostly agree. I do not view that as being in conflict with my views on deflation at all. If the U.S. dollar does not drop against Asian currencies, the euro, or the British pound, then where is the inflation in the price of finished goods? Nonexistent? Declining, perhaps? Does a price rise in gold affect the average consumer? How?

My point is that Robert Blumen more or less attacked a straw man without really putting together a comprehensive view of how his arguments fit together. In effect, it did NOT address the seven points I listed at the end of “The Deflation Debate Heats Up.” Yes, there are scenarios that may address each point individually, but the article is lacking a concrete explanation of how the inflationist argument all ties together. There was also no explanation offered as to why or how soaring gold affects consumer prices.

As best as I can tell, there is near-universal opinion about a housing bubble and subsequent bust, but no one has yet addressed all of the associated happenings when that occurs (e.g. loss of jobs, falling wages, rising defaults, lower demand for goods, overcapacity, the debt bubble, etc.) other than “The Fed will print its way out of it.” Remember, Japan tried that, and it did not work. Is the Fed truly all-powerful, to the point of being able to defeat the business cycle? If it is, why did we ever have recessions?

OK, Mish, next case.

Hyperinflation: Diatribes of a Deflationist

In “Diatribes of a Deflationist,” David Petch takes my rebuttal of Puplava point by point and addresses each one. This time, I am properly quoted. Thanks, David! Let’s take a look:

“The first point Shedlock states is oil is deflationary. Last week, I posted an article titled ‘Peak Oil and What It Means to You,’ and the take-home message is that competition for resources is going to happen, first economically, followed by military intervention as this century rolls out. I cannot remember a time in the 36 years of my life on the planet when oil was deflationary.

“The oil shortages of the ’70s were politically inspired. The inflationary trend at the peak saw housing prices decline 50% of the gain, yet they remained well above the low prices of the ’70s. My parents bought their second house in 1972 for $22,000. By 1980, it was [worth] approximately $55,000.

“The current shortages in oil are a geological phenomenon, not a politically inspired problem. As everyone is well aware, currency inflation is occurring daily, and now a coming shortage in oil will create commodity inflation. Companies will only be able to absorb so much of the cost before it inevitably is passed on to the consumer.”

There are many mistakes to this logic:

1. It assumes demand for goods will stay constant as prices rise
2. It assumes there will not be a switch to coal or uranium or other cheaper energy sources
3. It assumes renewable energy sources are not discovered
4. It assumes consumer discretionary spending in other areas is not drastically reduced in response to rising fuel prices
5. It assumes companies can raise prices and consumers will pay up
6. It assumes the world economy will not slow enough to negate the effect of China’s increasing energy demands.

Those are a lot of assumptions. Points 2 and 3 are long-term issues not really suitable for near-term discussion, but they may be important later. The other points were not addressed in Petch’s article. Yes, oil is in short supply, and yes, I believe in the concept of “peak oil,” but not addressed is the fact that the world is likely headed into a recession, which may negate most or all of that increased demand for quite some time.

Furthermore, rising oil is only inflationary when prices are passed on and wages rise so that other discretionary spending is not reduced to make up for increased oil prices. I see neither happening right now.

In fact, I see the opposite. This may be hard for inflationists to swallow, but here it is in black and white , in an article from The Independent:

“Factories cut the prices they charge their customers last month despite a record surge in raw materials costs, putting their profit margins under pressure and clearing the way for a cut in interest rates next month.

“Official figures published yesterday showed that manufacturers’ input costs rose at the fastest pace in June for almost two decades.

“Jonathan Loynes, the chief U.K. economist at Capital Economics, said: ‘This is good news for high-street inflation, but not for profits. Producers are having to absorb the bulk of the ongoing rise in costs, rather than passing it along the supply chain.’”

Hmm. Oil has gone from $25 to $60, and factories in the United Kingdom are cutting prices. How about that? That is not inflationary in my book. Seems like demand has fallen off the cliff in the United Kingdom, and it all started with a slowdown in housing. I have said this before, and I will say it again: The United Kingdom is leading the United States in this cycle by six months to a year. Expect the same action in the United States within a year.

Petch continues:

“Even though the current economy is a credit bubble, the creation of money automatically creates inflation as it feeds into the economy through debt. I am not an accounting type, but I am sure there exists neat little schemes for Fed-printed money to pick up struggling companies or to aid in transactions. Oil production is not increasing, and monetary expansion is occurring; therefore, prices will rise due to shortfalls, plain and simple. Factor in peak oil, which is commodity inflation, and the inflationary pressures build even higher.

“Assume the automobile sector and housing sector are commodities. There has been overproduction during both these cycles, and when a peak is hit, prices will stabilize, before plummeting. More supply than demand dictates commodity deflation will occur (housing and automobile sector). Notice how I am separating the terms of monetary inflation from commodity inflation or deflation.”

Petch sees both auto and house prices getting hit. Good, so do I. He also sees overcapacity. Great. That is a key deflationary argument.

Somehow, the debate turns back to oil, and my response to that is as above. Peak oil does not equate to unending demand and is no guarantee of either price inflation or monetary inflation with rising oil, as just proven in the United Kingdom. The point is that commodity inflation, not passed along, does not result in price inflation (and now I’m throwing out the term “price inflation” in addition to “monetary inflation” and “commodity inflation”). That, in fact, is where the rubber meets the road. If demand falls sufficiently enough or production (oversupply) rises fast enough, there will not be price inflation (which is what matters to the consumer and interest rates as well).

We are currently seeing oversupply in autos in spite of commodity prices, are we not? Are we not seeing price cuts and mammoth rebates as well? Pray tell, exactly what prices will be rising in finished products if we have a housing and auto busts? If rising oil and copper and steel prices (steel is now unwinding) did not cause the prices of cars to rise, exactly what will? Please answer that!

As for the credit bubble automatically causing inflation (while the bubble is inflating), once again, we agree (the effect is clearly seen in housing). But please look ahead: The busting of that bubble will automatically unwind the affects of that inflation. In other words, reverse it. Again, I point to action in the United Kingdom right now as a good example. Oddly enough, Petch even understands the basic premise (deflating asset bubbles and auto and house prices), yet fails to come to the proper conclusion about rising oil causing rising prices. He ignores the demand-side issues of oil as well.

Hyperinflation: So How Does This Affect Inflation?

Petch writes:

“Currently, the U.S. dollar index appears to have completed and elongated flat (wave C longer than wave A or B), and this pattern pretty much happens in triangle formations only. A triangle has five legs, and the first one for the U.S. dollar lasted 6.5 months. This translates into a U.S. dollar remaining range bound between 80.5 and current levels for another 24-28 months, before falling through 80. At this point, people will buy gold and silver bullion. They will line up like there is no tomorrow.”

So what? Other than lining up like there’s no tomorrow to buy gold and silver, I basically agree. Petch seems to agree with Faber, and so do I. I will repeat the reply I made earlier to Robert Blumen: Exactly how does this affect inflation in the price of finished goods? Does a price rise in gold affect the average consumer? How? As for a falling U.S. dollar, Faber seems to disagree, but I think it is likely. Thus, we agree again. The inflationary effects of a falling U.S. dollar will be resolved by falling demand for goods associated with a housing bust. Using Petch’s word, “overcapacity.”

Petch continues:

“Housing prices will decline as per a commodity deflation…Just because prices of one sector of the economy decline does not mean that everything else does. As an example, the Nasdaq and major markets in 2000 had severe declines, wiping out $5 trillion of equity, yet oil went from $10 per barrel to the recent high of $62 per barrel during the correction and since then.”

For the sake of clarity, this is in reply to one of my questions to Jim Puplava: “Even assuming [the government takes over GSEs, owning most American mortgages], how does that lead to hyperinflation?” Petch’s answer seems to agree that Puplava’s statement is nonsense as it relates to hyperinflation. Otherwise, trying to tie oil and the Nasdaq together makes no sense at all.

Petch writes:

“By forcing individuals to buy zero-coupon bonds, the government has a larger pool of capital to reduce the effects of their inflation agenda. For example, if the government can forcibly collect $500 billion per year from pension funds, then it can inflate at $500 billion per year without any net addition of capital to the system. This directly does not cause hyperinflation, but rather contains it.”

This is Petch’s response to another question I pose to Puplava. Puplava writes, “A national retirement security act is passed, forcing private pensions to buy long-dated zero-coupon government bonds that will be inflated away.” I respond, “Assume such a bill is passed — I seriously doubt it, but for the sake of argument, I will assume it happens. Pray tell, exactly how is that hyperinflationary? How and to what extent would it increase the money supply or cause prices to rise?”

It seems Petch has thought out the answer better than I could at the time. I accept that answer. Puplava’s hyperinflationary point just does not make any sense.


As best as I can tell, Petch agrees that two of Puplava’s hyperinflationary points are silly All three of us — Petch, Blumen, and I, as well as Faber and Puplava — ultimately see a bright future for gold as a result of the Fed trying to stimulate the economy in a housing bust. Even so, I fail to see (and no one has even tried to explain) how rising gold prices causes other consumer prices to rise. Unless that happens, rising gold prices are more or less meaningless, except to those holding gold.

As best as I can tell, then, Petch’s hyperinflation rests solidly on oil (or perhaps other commodities), even though we have not seen much pass through yet, especially in autos. For multiple reasons, the assumption of forever-rising oil prices is, in and of itself, on shaky ground (near-term anyway) in the face of a consumer- or housing-led recession.

Hyperinflation: The Nut Hyperinflationists Must Crack

More to the point, I fail to see how either Petch or Blumen or Puplava have addressed the heart of this debate. I will repeat it.

Here is the nut hyperinflationists need to crack:

1. Falling home prices
2. Falling wages
3. Stagnant employment or rising unemployment
4. Slowing world economy
5. No incentive for the Fed to bail out consumers at the expense of banks
6. The K-Cycle is not likely to be defeated by throwing more money at the problem
7. At some point, lenders refuse to lend or borrowers stop borrowing. That time will be at hand when housing plunges. Look at current events in the United Kingdom as a prelude for what will happen here.

What I see is Petch and Blumen (who have responded) and Puplava (who has not) failing to address the above scenario in a logical manner consistent with a housing bust (obviously, accompanied by huge job losses in the housing sector) and additional outsourcing of jobs to China and India to cut costs, accompanied by falling demand for goods. Since we all seem to agree on a housing bust, I am still searching for a logical scenario that causes “price inflation” in the face of that.

Not only do I think we will see price deflation (certainly in assets like stocks and houses), but I also believe the destruction of credit (and money) in the next down cycle will be enormous. A rising oil price is NOT the “hyperinflation answer” for many reasons, in theory and, as the United Kingdom has proven, in actual practice. Furthermore, if the recession is deep enough (as I suspect it will be), oil prices are likely to fall, peak oil or not.

For the record, I am convinced that Petch will be eventually correct and that oil prices are going to rise over time, to substantial new highs, from these levels near $60. That timeline is a long one, however, and near term, I expect flattening or declines as the worldwide recession kicks off.

There is a nice chart in Petch’s article showing inflation headed up for something like forever, and I would be remiss if I did not address it. Here goes…

Be very, very careful about extending trends to perpetuity. They don’t get there. I offer the Nasdaq bubble as proof. Faber warns about that in his excellent book Tomorrow’s Gold. It should be on everyone’s reading list. I also recommend The Dollar Crisis by Richard Duncan. My thinking has been heavily influenced by both of these authors.

Finally, let me state the possible scenarios leading to inflation as best as I can, since no one else seems willing to take it on. Here are two scenarios that will work…

Scenario A:

1. Increasing demand for commodities from China
2. Housing prices stay strong and economic activity picks up worldwide
3. U.S. wages rise
4. Rents rise
5. Demand for goods in the United States stays strong
6. Demand for goods in Europe picks up
7. Demand for goods in China picks up

It may not take all of those, but it would take a lot of them to be consistent with sustained inflation.

Scenario B:

1. Demand increases for commodities from China in the face of a U.S. housing bust
2. Consumers keep spending money and banks keep lending even as asset prices fall
3. If consumers stop spending in the face of job losses associated with the housing bust, the Fed goes on a mad printing spree
4. Since the Fed can print money, but not force the consumer to drink (increase borrowing), a “helicopter drop” is issued (whereby Congress passes laws that literally give money away to consumers)
5. The helicopter drop is done in the United States only, and other countries refuse to finance it (if everyone did it, the U.S. dollar would not drop)
6. Banks and other creditors have no say in this and are destroyed, along with the Fed, in the hyperinflation that takes over
7. The consumer is bailed out at the expense of big creditors like Citigroup, American Express, Visa, MasterCard, etc.
8. The business cycle is defeated; there will never be a recession again
9. Consumers never need to save again, but rather are bailed out by rising asset prices

Again, it may not take all of those, but it would take a few crucial ones: The Fed and Congress acting together to bail out consumers at the expense of creditors. It would probably have to be only U.S. related for the dollar to get smashed versus other fiat currencies.

That is what I am looking for: A logical scenario that addresses the full implications of a housing bust, or some sort of scenario that addresses the full implications of a Fed that voluntarily produces hyperinflation. Petch tries to address the issue with “asset deflation” versus “monetary deflation” in a scenario mainly tied to oil, but that scenario ignores falling demand issues as well as the possibility (likelihood?) of oil prices falling. Even IF oil prices do not fall, evidence shows a lack of pricing power on finished goods.

Should someone think the second point in Scenario B is likely, I disagree and point to the United Kingdom (now) and Japan (for the past 18 years). In addition, in the face of falling home prices, it is logical to assume banks will tighten standards to prevent defaults or consumers will pull in their horns or, most likely, both.

Finally, I do not think hyperinflation was ever voluntarily and purposely attempted (to bail out consumers), but that seems to be what is suggested by all these “helicopter drop” scenarios. Threat, yes, but in practice, no. Thus I find both of the above scenarios to be absurd. The Fed and the powers that be will not voluntarily destroy themselves. Will they fight deflation? Yes. Will they fight deflation to the point of destroying themselves? No. That would not only require printing presses, but action from Congress as well. The scenario is simply not consistent with a Congress that passed “bankruptcy reform” to keep consumers indebted forever.

Bottom line: I expect to see a prolonged period (5-12 years) in which deflation is predominate, interspersed by temporary stock market rallies, with long-term interest rates slowly sinking to 2.5% or so.

Mike Shedlock
July 21, 2005