Hyperinflation: What is hyperinflation


Hyperinflation: What is hyperinflation?

Hyperinflation isn’t just an increase in the money supply; after all the central bank increases the money supply all the time, a phenomenon we know as simple inflation and which we come to expect as a constant. Hyperinflation, however, happens when uncertainty in the future worth of the currency causes people to start trading it for things of actual utility and more reliable stores of value as soon as they can. The velocity of paper money through the system increases as people seek to get rid of it.

So hyperinflation isn’t just the expansion of the monetary base, though the expansion is at the root. The expansion is fuel, but the conflagration doesn’t start till the herd panics.

Citizens generally know that the paper currencies they are forced by law to use aren’t quite as good as gold. There is an oily, slippery quality to the paper. That its value will go down gradually over time is a given, but most folks deluded themselves into believing it’s for the best and that the government has it all in hand. But eventually a nation has to face the inevitable outcome of government trying to manage an economy; centralized planning leads to misinvestments on a colossal—even global—scale. These are paid for by the stealthy tax of inflation…and eventually the whole thing collapses.

Hyperinflation: How does it happen?

The government borrows money into existence (from the central bank) and then spends it into the economy. Governments and central banks technically are separate entities, but they collude with each other like this all the time. When citizens and foreigners won’t lend (buy bonds) and raising taxes isn’t enough, the central bank is always there willing to play ball.

The central bank can increase the monetary base as much as it wants…because it’s the entity that issues the currency. It then uses that currency to buy bonds from the government, which is just a convoluted way of saying it loans this money to the government so that the government can continue to spend money. Of course if anyone else tries this sort of legerdemain, it would be called counterfeiting. When the government and central bank does it, it’s considered economic stimulus. Then the government can spend this new money into the economy by its usual favorite venues: wars, welfare and—in times when stimulus is called for—an alphabet soup of make-work programs.

Hyperinflation takes off when the entire population gets wise. The money supply might have been growing in fits and spurts for decades, but the hyperinflationary storm happens when that money really starts to move around as people try to get rid of it. The prices of useful goods get bid up to embarrassing levels. The process accelerates when governments try to stabilize markets…often by adding more paper…because honestly, what else can a government do? Mismanagement and fraud are the only things governments really get right consistently. So for the government a problem that’s caused by the theft of inflation can only be solved by…more mismanagement and fraud. The entire process is self-reinforcing and results in the hyperinflationary death spiral to which all currency is heir.

Hyperinflation: A brief history

Before paper money, rulers would just debase the coins—that is remove the quantity of precious metals in each and increase the number in circulation. Each coin had less gold or silver in it, though the rulers who issued the currency would insist—on pain of death—that everyone pretends that the coins were worth just as much. This sort thing led to Sir Thomas Gresham’s pithy maxim: “bad money drives good money out of circulation.” That is to say that people generally aren’t fooled by a debased currency and will hold on to the unadulterated forms of money while they use the debased stuff for their transactions. They use the debased stuff for day-to-day transactions, but put the good stuff under their mattresses.

Inflation and declining value have been features of fiat currencies since their inception in China about a millennium ago. Hyperinflation is a new mutated version of this ancient terror, born in the 20th Century. The most famous example worked its horrors during the Weimar Republic period in Germany. In 1921 a dollar was worth about 50 German Marks; by the end of 1923 the exchange rate was 4.2 trillion Marks for a dollar. Onerous demands by the British for war reparations forced the German government essentially to pay with the futures of its citizens.

Hyperinflation: Why does this matter now?

This matters now because the new administration is going to “monetize the debt.” They are going to create new money in order to bail out various banks and businesses and even mortgage debtors. But again, governments may be able to create money, but they cannot create purchasing power. It’s a swindle. The money they create dilutes the value of that already in existence. It is a way to siphon purchasing power from those trusting souls who have saved in the currency. It’s an indirect and subtle tax. This is wrong in principle and disastrous in practice.

This sort of thing can’t happen when the money is just a stand-in for gold. Then the money supply is fairly fixed. But that sort of thing ties government’s hands. When you want a strictly limited constitutional government, that’s a good thing. Of course, if you want centralized planning, market interventions and wars, gold standards are horribly restricting. That’s why governments get rid of them as quickly as they can. Then there is absolutely no need to be fiscally responsible. Then governments can use all the usual means to grow in scope and reach: the wars, welfare and market intervention previously mentioned.

Hyperinflation: Myths?

When speaking of the collapse of a currency, people often trot out the adage “you can’t eat gold.” By this they mean that in a true currency crisis and attendant collapse, only fuel and food and the arms to protect them will have any value. Gold, despite being branded a barbarous relic by Keynes, is actually a symbol of civilization and trade. Therefore it won’t perform its monetary function when civilization and trade break down.

In a true collapse, there may be no trade at all or what little trade there is could be limited to barter. As long as there is any exchange being done, people will find something to use as money; the guy with the cows and the milk you want is not always going to want the furs you have to trade. If trade goes on at all, even if barter is a large part of it, precious metals will have a place. They’ve been used as money for thousands of years because they perform the function of money so well.

On the other hand, a common assumption is that gold is absolutely the best thing to hold during hyperinflation. Not necessarily true. It will do a lot better than the failing currency…but a hyperinflationary scenario means that just about everything is doing better than the failing currency…the currency is the one thing that no one wants to hold. Depending on where things are at the start, however, it may not do the best.

Real estate is traditionally a good hedge against currency failure, but in recent history real estate prices were extremely overblown all over the western world by access to credit in the form of the leveraging instrument known as the 30-year mortgage (100-years in Japan during its bubble) and exotic permutations thereof. So gold in this particular situation has a bit of head start on real estate which itself has a further to fall. And speaking of real estate and other falling asset prices…

Hyperinflation: What about deflation? Isn’t that what we’re experiencing now?

Don’t count on deflation in any real sense. Under a fiat currency, deflation can only ever be a short-term phenomena, and it generally only occurs when available credit contracts. Also keep in mind that credit is something that banks can over-issue far above actual reserves thanks to those pernicious fractional lending laws. Credit is like an appendix to the actual supply of money; some folks count it in the measure of the overall monetary base, while some don’t. It’s a fact that it can deflate and the effect on the economy is indeed very deflationary as prices bid up by credit collapse (housing is a very obvious example, but luxury items and even needed commodities are affected by availability of credit) and activity dependent on credit ceases, and the jobs attached to those activities disappear.

Credit distorts prices. It’s how the banks—under direction from the central bank—gets the disaster rolling. Fractional reserve lending laws allow banks to make loans far beyond what they actually have on reserve (a fraction of those reserves, hence the name). Assets get bid up with credit and bad business ideas get funded. People get all sorts of false signals because of the availability of credit and bad decisions get made. Debts grow on all sorts of unproductive purchases and ventures.

This can’t go on forever—borrowing from the future and on reserves that aren’t really there. When it stops working, those debts have to be worked out somehow. The temptingly easy way to do this is to devalue the debts and make them easier to pay. A little inflationary easing thus seems like a really good idea. That’s how governments make inflation palatable to their subjects. It makes the weight of bad financial decisions easier to bear.

The government labels this sort of thing as “economic stimulus” or “quantitative easing”, though a more honest description would be “defrauding the minority of savers” and “prolonging the inevitable painful outcome of propping up misinvestments.”

The Daily Reckoning