The Joys of Hyperinflation

Credit isn’t wealth. A lot of people are discovering that the hard way. Welcome to the credit deflation prelude to hyperinflation.

During a credit deflation, things get cheaper. Without lines of credit, people can’t bid things up and prices fall to their “cash on hand” level. Given a long enough time, things settle out and prices relative to wages actually become attractive. But it’s a long and bumpy ride from here to there. The trick is to maintain roughly the same level of income as others take wage cuts or lose their jobs entirely. Add this to the general lack of credit and you find that the cost of living drops dramatically. You might have felt poor a couple of years ago when you earned $50,000 per year, but if you can hold onto that income, why, in the next couple of years you could feel positively wealthy!

The holding on part is where it gets a little tricky.

It’s tricky because when credit evaporates, less goods and services can be bought. A lot of jobs providing those goods and services become unnecessary. Layoffs become all the rage. You wind up with a lot of formerly employed people with no jobs and no money and no attractive prospects. Doesn’t seem fair, but that’s what happens when hopes and livelihoods get propped up on the shifting sand of credit expansion.

When credit vanishes, actual cash becomes king. Promises to pay take a back seat to actual ability to pay. Exactly what are we calling “cash”, though? God and the free markets like gold and silver because they’re relatively rare, easily divisible, and it’s very difficult to control their supply, and hence they’re innately honest. Governments prefer colorful bits of paper that they issue precisely because they can print up as many as they need.

While credit isn’t wealth, neither is money. Money is just a commodity we use to represent and exchange wealth. It’s rather vital to have a measuring tool that resists stretching and deformation or else you get into all sorts of trouble. Gold and silver tend to resist stretching; paper money begs for it.

During the last really big credit bust in this country cash was very strictly tied to gold and silver. The exchange rates were fixed; you got one ounce of gold for a twenty-dollar bill (plus 67 pennies). Fifty-four cents got you an ounce of silver. So when the credit bubble popped and prices slumped, they did so in terms of a dollar that was a reliable proxy for gold and silver. How things have changed!

First FDR devalued the dollar and a little later Nixon killed it. The currency we have today is a hoax wrapped in a lie. It isn’t tied to anything. The old dollar was a certificate that could be exchanged for a very specific amount of gold. The one we’ve had since 1971 is a promise from the U.S. government…and little paper promises from governments have a dismal history.

You might have noticed that during our recent gargantuan credit bust people again ran to the dollar. They expressed a very strong preference for greenbacks over…well, just about everything else in the wide world. But running to the dollar for shelter these days is like seeking protection from the man who is shooting at you…or running from the doorway of a burning building to the second floor.

During the last depression, the dollar’s tie to gold limited the ability of our communist dictator to goose the money supply. Roosevelt had to coerce the citizenry to give him their gold under pain of imprisonment so he could allow for some easing of the dollar’s value. This time around, FDR II can just have central banks conjure up as much cash as deemed necessary out of nothingness because the dollar isn’t tied to gold anymore.

Inflation is a slow burn on its default setting, which governments enjoy so much. It’s why they insist on monopolizing currency in the first place. But let inflation go on long enough and the currency becomes worthless. Sometimes events conspire to accelerate the race to worthlessness. Wars, laughably unpayable national debt, financial panics…that sort of thing.

The government would prefer an endless boom, even though such a thing—like individual biological immortality or perpetual motion — just isn’t possible. The central bank gets things started by expanding credit. Good times ensue. Everyone is employed and everyone lives beyond their means and bids up the prices of assets with money they don’t really have. This can’t go on forever (and never does!), but governments hate to see the ravages of the inevitable contraction after their artificially-induced boom. States love for their citizens to be blissfully distracted with fantasy, especially the really unsustainable sort.

So what is a government to do when it wants people to spend and they just refuse? When the rubes refuse to play ball and insist on hanging on to their savings, all you have to do is make saving less attractive than spending. Increase the money supply…make the money people hold less valuable…encourage them to get rid of it. Set the currency ablaze and ferret the consumers out.

Around these parts, we subscribe to the view that savings are essential for capital investment, but politicians side with Keynes on this and believe savings are for suckers; debt is where it’s at. And if private debt has brought the population to its knees, then the obvious answer is a dollop of public debt to kill their currency and finish them off!

It’s not just the amount of dollars that the central bank produces, however; it’s the amount that actually gets circulated and the speed at which it moves through the economy. When the general populace senses that the dollars they’re holding are losing value (because the central bank is accelerating the increase in supply), they try very hard to get rid of them as quickly as possible. They trade them for things that will hold their value.

The real trouble with hyperinflation isn’t that it devalues the currency, however; it’s that it devalues souls. It leads people astray. It removes the moral stops. It changes all sense of proportion. Like a sadistic, juvenile prankster, government spikes the punch with a little quantitative easing and before you know it all bets are off. People drunkenly succumb to the baser instincts they normally keep in check. The thin layer of restraint provided by the neo-cortex is broken and all sorts of reptilian longings are indulged…and consequences be damned.

Trying to invest and plan for the future under a fiat currency regime is like trying to be witty and convincing while drunk. Inevitably the wrong things are said and done because perception and judgment are hopelessly warped.

During a hyperinflation, the majority of the population who counted on the scrip they were forced to deal with and save can only feel angry desperation as all their savings turn to ashes practically overnight. The reward for personal thrift coupled with trust in the largest institution around—the state—is loss and future uncertainty. Under such conditions, societies tend to come apart fairly rapidly. Crime rises as savings and incomes disappear. Ethnic tensions may mount. There is a bull market in internal strife and personal misery.

People generally rather consume than produce or delay gratification. This is why the masses can be lied to with paper. But the universe is a weighing machine, not a voting booth. Wishes don’t trump reality. And disaster must befall those who expect something for nothing. We here in the Whiskey Room like to point the finger at governments, but we also have to acknowledge that thing in human nature that allows governments to exist in the first place and to flourish.

For the past decade in the U.S. easy credit — pretend money — led people to put their houses up as collateral on debts that could only be paid back if real estate prices kept getting propped up by more easy credit. Then they used this debt to finance vacations and trips to big retails chains to buy things that would not be used to produce or store wealth. And this was just an expansion of credit!

When the actual money supply expands in order to ease debt repayments…well, all sorts of screwy things happen. That’s what generally spurs the vulgar expansion of the money supply: the political desire to ease massive debt repayment, both public and private…that and war. When you see a nation living beyond its means, watch out; its currency will be thrown under the bus when the bill comes due.

Destroying the currency, however, means that the debts really weren’t repaid…because they were paid back with dollars that aren’t worth the value of those that were initially borrowed. It’s a big swindle and everyone involved knows it. But it goes on anyway with all the nasty consequences you’d expect from such massive debauchery, delusion and theft.

The list of countries that have suffered the ravages of paper money hyperinflation is pretty darned long…and ironically it starts with the very first country to give paper money a try, long, long ago. China’s Yuan Dynasty’s little experiment with paper money ended badly. In fact, it helped end the Yuan Dynasty.

For the first time in history, currencies everywhere are merely paper…including the world’s reserve currency. The potential…the inevitability…of a worldwide bonfire of these little paper vanities staggers the imagination. The conflagration will be mesmerizing in its size and intensity. You may even find yourself enjoying the view…if you make it a point to be standing far enough away not to be consumed.

Gary Gibson
Managing Editor, Whiskey & Gunpowder

February 17, 2009

The Daily Reckoning