Hyperinflation talk has come to the forefront once again (thanks to a few recent articles), and being my #2 (of 2) topic here at FOFOA, I have a small but relevant offering for you. This is a compilation of a few posts from a recent discussion I had on another forum. The subject was hyperinflation and the deflationists that emphatically say it is impossible here. And the question was asked, What do these deflationists mean by deflation? Monetary deflation? Price deflation? Asset deflation? And so on. "What is deflation?" was the primary question.
Always looking for a fresh angle, which I like to do, I thought a much more interesting question was, "What is a deflationist?" The term deflationist is one I have been using regularly on my blog for two years now. And it is a term that I appropriated, definition and all, from FOA's writings a decade ago. Here are a couple of his "deflationist quotes" to kick off this post…
"Somewhere in the 1970s era I was exposed to the thinking of several different deflationists. It seemed that all of their conclusions came to the same end: that dollar deflation would rule the day, no matter what. Mind you now,,,,,, most of them were split on the finer points of the issue, but for all of them; Deflation was always the final outcome."
And of course his most famous one…
"My friend, debt is the very essence of fiat. As debt defaults, fiat is destroyed. This is where all these deflationists get their direction. Not seeing that hyperinflation is the process of saving debt at all costs, even buying it outright for cash. Deflation is impossible in today's dollar terms because policy will allow the printing of cash, if necessary, to cover every last bit of debt and dumping it on your front lawn! (smile) Worthless dollars, of course, but no deflation in dollar terms! (bigger smile)"
What is a Deflationist?
What is a deflationist? It is one who looks very closely at the present structure of everything, the laws, the rules, the regulations, what is supposed to happen, who should fail, etc… but ignores the political (collective) will that backs it all up. The same political will that always changes the rules to suit its needs as surely as the sun rises. And it is this political will that makes dollar hyperinflation a certainty this time around.
It is beyond frustrating to watch all the bailouts of banks at a time like this. They should be allowed to fail! Right? But this ugly sight is only a symptom of the real problem. And it was never even a choice. As FOA warned 12 years ago, these bailouts were always baked into the cake. They are a mandatory function of the political will that backs the entire system. This is the main element that all of the deflationists miss.
Unlike FOA, the deflationists never saw the bailouts or the QE coming, and they refuse to believe that it will keep on coming as long as ANYTHING keeps failing. States, pension funds, large companies, foreign entities, whatever. It's all gonna be papered over. And the choice to stop bidding on dollars rests solely in the hands of those with large stockpiles of physical gold.
Once they stop bidding for dollars with their gold, the goose is cooked. (See: " Dollars Bidding for Gold? Or Gold Bidding for Dollars?" here.)
In a recent interview over a couple beers, one self-proclaimed deflationist said this:
The hyperinflation case, if one wants to make one, and I'll make one right now, is congress sends everyone $60,000, that would probably do it, but is congress likely to do that? …All this talk about the Fed being able to drop money out of helicopters, that's not the way it works.
In my last post, Credibility Inflation, I wrote the following:
First of all I would like to clear up probably the most common misconception about hyperinflation. What most people believe is that massive printing of base money (new cash) leads to hyperinflation. No, it's the other way around. Hyperinflation leads to the massive printing of base money (new cash).
Hyperinflation, in most people minds, conjures images of trillion dollar Zimbabwe notes. But this image is simply the government's reflexive response to the onset of hyperinflation, which is actually the loss of confidence in the currency. First comes the loss of confidence (hyperinflation), then, and only then, comes the massive printing to keep the government and its obligations afloat.
Can you see that the above deflationist is basing his view of hyperinflation on this misconception? We don't need the helicopter drop to spark hyperinflation. Zimbabwe didn't have billion dollar notes when hyperinflation started. They only had Z$100 notes just like the US. The million and billion dollar notes followed the onset of confidence collapse as the government printed to survive.
Another consideration is that sometimes there is a "deflationary
head-fake" right before the onset of hyperinflation as the private bank credit money disappears...
With these charts I am not saying it always looks exactly the same. I am only observing that the common deflationary metrics can fall while credit collapses, but then be immediately followed by a confidence collapse in the currency itself. Deflationists don't see this because they are viewing the economy as if it were a machine. And machines don't flip 180 degrees on a dime like this.
I tend to agree with 99% of what the deflationists write. For the most part they are masters at analyzing the minutiae and then painting it into a grand macro picture. I like the Kondratieff cycles and I agree we are in the winter cycle. In fact, almost everything most deflationists describe will probably happen, in my view.
But they all miss the hyperinflation that is coming. And they miss it because they don't understand how perfectly it fits with a deflationary collapse. In fact, they argue vehemently against it the same as they argue against inflation, which is how I know they don't understand hyperinflation. And they miss it because they are so meticulous in their observations and calculations that they can't see that the collective will always changes the rules when things get really painful. The political will (which is the same as the collective will in my lexicon) always does whatever will lessen the immediate pain, even if it will most certainly cause greater pain later. This is the part that is as reliable as the sun rising.
See All Paper is STILL a short position on gold if you have not already. It was an early but very popular post I wrote in response to a deflationist's article titled "Hyperinflation is Impossible."
Here's the main thing: the deflationists make all their calculations in dollar-denominated terms. They can't help it. It's as natural and automatic as breathing air to their Western minds. But this small flaw in the numéraire of their calculations leads them to funny conclusions about the future value of dollars. For one thing, the coming deflation must be in dollar-denominated terms, they believe. But this is impossible today. Because we have a purely symbolic currency, a dollar-denominated deflation is impossible... because of the political will I mentioned above!
Yes, we will have a grand deflation... denominated in GOLD! It will be brought on by all the same factors the deflationists correctly recognize. The failure of debt, the winter cycle, etc... And it will look the same as they imagine. Depression, unemployment, falling prices (when priced in GOLD), black and white pictures, etc...
You see, hyperinflation is exactly like deflation. The only thing hyperinflation has in common with inflation is part of its name. Other than that it looks just like a deflationary depression. In fact, it IS a deflationary depression, with a different numéraire! Just look at Zimbabwe a couple years ago. Other than the fancy wheelbarrows, it looked just like a depression.
Now you might ask, "What's the difference between a deflation denominated in gold versus dollars?" Well, there's a huge difference to both the debtors and the savers. In a dollar deflation the debtors suffocate but in a gold deflation they find a bit of relief from their dollar-denominated debts. And for the savers, the big difference is in the choice of what to save your wealth in. This is what makes the deflationists so dangerous to savers.
The deflationist equation, if properly applied, always leads to the conclusion that the best things to save are cash and Treasuries. And some (not all) deflationists even apply their formula to gold (because they believe it will behave like a commodity) and conclude it must crash to around $200/oz during their deflation. So they warn their readers to stay away from gold.
Can you see how one little flaw in the numéraire can make an analyst very dangerous to your bottom line?
Here is the way the deflationist views the world. Think of all the debt as a large balloon. As it is expanding the balloon is being inflated. Today that balloon is deflating and no matter what the Fed does, it can't seem to reflate that balloon. And the deflationist concludes that as long as that balloon is deflating, not inflating, we MUST have deflation, and the value of a dollar MUST rise.
But here is the correct way to picture it. There are actually TWO balloons side by side. These two balloons are the two sides of the global balance sheet. One belongs to the debtor and the other to the saver.
If we think about "global debt" as "global liabilities," then there must be the equal and opposite "global assets." Simple balance sheet math. The liabilities are failing because collateral values are falling and debtors are defaulting. As FOA said, "As debt defaults, fiat is destroyed." Or another way to say is, "As debt defaults, fiat savings are destroyed."
But what is actually happening is the assets are being papered over with fresh base money. FOA: "hyperinflation is the process of saving debt at all costs, even buying it outright for cash." Or said another way, "hyperinflation is the process of saving debt-backed assets (MBS's etc..) at all costs, even buying them outright for cash."
These two balloons are a metaphor for the global balance sheet with an "airy" elastic bubble-like quality since we are talking about "inflation" and "deflation." They are a way to visualize the two sides of the balance sheet inflating and deflating in tandem like they're supposed to, and then separately as the debt-backed assets are saved at the cost of destroying the transactional currency.
In the beginning, as the debt balloon expands so does the savings balloon. And this second balloon expanding represents credibility inflation (see my last post). Credibility inflation is the confidence the savers have in saving the debtor's debt. And this is what enabled the debt bubble to grow so large in the first place. And in a circular fashion, the debt also allowed the savings bubble to grow so big, bigger even than the underlying world of real things.
So in the early stage we have a feedback loop of credibility inflation. Debt creation inflates the amount of "stored wealth" and this "stored wealth" (stored as someone else's debt) enables more and easier debt creation. Subprime loans and MBS's are a perfect example of this kind of a feedback loop. The invention of Subprime fed the MBS phenomenon, and the MBS phenomenon enabled (and demanded) the invention of Subprime. And today's credit contraction is a sure sign that the feedback loop is no longer functioning. Banks don't like to extend credit unless they can immediately sell the resulting hot potato of "stored wealth" to a pension fund or some other sucker.
Anyway, the future hyperinflation fuel is stored in the savings balloon during this period of credibility inflation. (Again, see my last post.) That's why we see very little price inflation during this stage. And when the debt starts to fail, so does the credibility of paper debt to the savers. The Fed is trying desperately to restart the credibility feedback loop that will reflate the deflating debtor balloon. That, of course, is impossible at this point; an observation the deflationists intuitively make correctly, even though they are only looking at one of the balloons.
So as the credibility of debt paper as a savings instrument fails in the mind of the savers, that hyperinflation fuel stored in the savers' balloon turns into real price inflation as it scrambles to be spent. Remember that this savings balloon has grown larger than the underlying world of real things!
Now here is where the deflationist would stop me and say, "Wait a minute. Both of your balloons are deflating at the same rate so your 'savings' could never escape." But this is also where the political (collective) will comes into play. It will NOT let that savers' balloon deflate. The Fed is helpless against the debtors' balloon and the credit/debt feedback loop, but it is most certainly NOT helpless against the savers' balloon.
The Fed has the power to keep the savers' balloon 100% full if it wants to, and the political will to fully back that action. It simply buys those deflating MBS's (etc..) at full price ("dumping them on your front lawn! (smile)") and suddenly the air in the savings balloon has been replaced with non-elastic fresh cash. This process is already well underway… and IT IS the trigger for hyperinflation.
Remember, first comes hyperinflation, then, and only then, comes the massive printing as the Fed tries desperately to keep the government functioning. So don't look for massive printing to see hyperinflation coming. Look for the monetization of bad debt and the first signs of real price inflation, even in the face of apparently deflationary forces.
A note: Gold could sop up most of the hyperinflation presently stored in the savers balloon without destroying the real economy (see my old post Freegold is like a Giant Sponge). But it is the US Govt. that will make sure this becomes a real Weimar-style hyperinflation when it forces the Fed to monetize any and all US debt. And as dollar confidence continues to fall, that's when the debt must go exponential just to purchase the same amount of real goods for the government. One month the debt will be a trillion, the next month it will be a quadrillion just to buy the same stuff as the previous month. How long will this last? Less than 6 months is my guess.
Another Angle
There is another important angle to this story that the deflationists all miss. You may have caught it if you thought to yourself, "Well, even if the Fed keeps the savers balloon 100% full while the debtors balloon deflates, that's only half the money supply as before." This is exactly how the deflationists think. They see no difference between the two.
But there is a fundamental difference between the kind of money that fills the debtors balloon (credit money or balance sheet money) and the kind the Fed is using to prop up the savers balloon (monetary base). This is a critical difference that deflationists can't seem to wrap their heads around (and I'm not sure why).
You see credit money is tied to the functioning of the economy and base money is not. As the debtors balloon deflates, so does the functioning economy, and so does the real world of goods that backs the money supply. Base money does not contract along with the economy like credit money does. And base money is the fuel in all hyperinflations while credit money vanishes!
As the economy along with the debtors balloon contracts and the confidence of the savers wanes, the previous driving force of greed switches to the much more powerful force of fear. And "switch" is a great word in this case, because this transition can hit the entire planet all at once as fast as flipping a "light switch." It's called a panic.
When it does, that's when the velocity of the monetary base takes off. And as I have pointed out before, velocity has the same exact effect on the value of a dollar as an increase in the money supply. (See my "sea shell island" analogy here.) If the velocity jumps from fear, base money can chase scarce goods with the same disastrous effect as an exponential increase in the money supply, even before that actually occurs.
Richard Maybury describes it well here:
...velocity & money demand.
Jim Powell has pointed out that the tens of millions of people who are still working — and that's 91.5% of the workforce — have received a huge pay raise, because prices of houses, cars, refrigerators and a lot of other things, have been cut drastically. The buying power of their wages has soared!
And, it's the best kind of pay raise, because they didn't need to work any harder to get it, and it's not taxed.
This is a huge windfall. It's probably the biggest, most widely shared windfall in all of world history.
So why aren't these tens of millions of people out celebrating? They should be delirious with joy. Why aren't we seeing dancing in the streets?
Because people are scared and afraid to spend the money. And that brings us to what economists call velocity.
As this war was developing during the 1990s, I repeatedly warned that it was likely to bring a dollar crisis, and advised my readers to always have part of their savings diversified into non-dollar assets such as Swiss francs, New Zealand dollars, gold, silver, platinum, oil, and other raw materials.
Incidentally, in March on our web site, I ran a special bulletin telling my readers that I think there is an 85% probability the bottom in non-dollar assets has occurred, or is occurring, and I think those investment suggestions are now as solid as they were ten years ago.
A major reason is velocity. As far as I know, my Early Warning Report is the only publication that says much about it.
I think velocity has become the key driver in the entire world-wide economic crisis, so here is a quick explanation of it.
Money responds to the law of supply and demand just as everything else does.
If people do not want a particular currency — let's say the British pound — then the value of a pound will fall.
Sellers will demand more pounds in trade for their goods or services, and prices in Britain will rise, even if there has been no change in the supply of pounds.
On the other hand, if the demand for pounds rises, the value will rise and prices will fall even if there has been no change in the supply of the currency.
Velocity is the speed at which money changes hands. When demand for the money is high, money changes hands more slowly, and velocity is low.
When demand for the money is low, velocity is high.
A key point is that velocity and money supply can act as substitutes for each other. A 10% rise in velocity has the same effect as a 10% rise in money supply.
The biggest problem with velocity and money demand is they can turn 180 degrees overnight. If people trust the currency, and suddenly perceive some kind of big threat to their futures, money demand can shoot up.
That's exactly what happened last year. The supply of dollars certainly did not go down, but when the real estate crash happened, people became so frightened they were afraid to let go of their dollars.
Within a few days, money demand shot up, people stopped spending and held onto their dollars, and this had the same effect as an instantaneous deflation of the money supply.
If you don't spend your money, that's the same thing as taking it out of circulation.
This can instantly cause the equivalent of a sharp deflation of the money supply by 10 or 20 percent, or more.
That's what happened in the Great Depression. The Fed was inflating. In 1932, the money supply[1] was $20 billion, and by 1940 it was $38 billion. But fear was so great that velocity was falling faster than money supply was rising.
This is why Franklin Roosevelt said in his first inaugural speech, "The only thing we have to fear is fear itself." People were afraid to spend their money, as they are now, and velocity was falling, which has the same effect as deflation, because if you don't spend your money, it's not in circulation.
So, speaking economically, I think that is where we are now. Changes in money demand and velocity are running everything.
And, my key point is, it's all controlled by emotions. By fear.
What are you more afraid of? The dollar becoming worthless? Or losing your job and running out of dollars?
The whole world is constantly shifting back and forth between those two fears, so money demand bounces up and down like a yo-yo, and velocity — the speed at which the money changes hands — does, too.
These wild shifts in money demand and velocity have the same effect as massive, instantaneous shifts up and down in money supply. It's like we're having a huge inflation, then a deflation, every few hours — because our fears change every few hours — because the politicians have all this arbitrary power and we don't know what they're going to do to us!
Now, do you see why it is so important to see the economy not as a machine but as an ecology. Machines don't feel, they don't have fear, or joy, or optimism.
But people, biological organisms, do have feelings. They do fear, and their fears can change instantaneously.
The human ecology, especially these days, is driven very largely by emotions.
How are the politicians and bureaucrats who are playing God ever going to control, or fine tune, or repair, or speed up or slow down, our emotions?
This is an excellent description of what the deflationists see, and also why they don't see the rest of the big picture. They view the monetary world as a machine rather than a human ecology. They underestimate the will of the "politicians and bureaucrats who are playing God." And they also underestimate the power of fear and monetary velocity.
And now that you have a little bit of understanding about the difference between economically-tied credit money and base money (cash or its equivalent), as well as the power of fear and velocity, I want you to notice that the hyperinflations of the past have all played out with base money, not credit money, at the helm.
This is where all those "excess reserves held at the Fed" become very dangerous. You see, those are monetary base reserves, not credit money. They may not be physical cash yet, but they are contractual obligations of the Fed to print actual cash. And if velocity picks up in a panic, that's exactly what the Fed will have to do in order to keep the banking system from collapsing. Deflationists think this is a choice the Fed will have to make, but it is not.
It is already happening to a smaller degree with the Friday bank failures. Ever since the FDIC ran out of "reserves," every failed bank has been propped up with more fresh base money. "Saving the savers' deposits!" Converting them from credit money into base money in whatever amount exceeds the failed bank's marked-to-market assets.
So there is already enough fuel in the system to feed the fire when it starts.
And when it starts, that is when prices start to rise... price hyperinflation. And as prices rise, the government will need more money to pay for the same amount of "governing" in each successive cycle (monthly). This is when the monetary hyperinflation takes over and gives the price hyperinflation its HYPER boost.
Deflationists often refer to "foreign-denominated debt" as the cause of hyperinflation and also as their ace-in-the-hole reason why the dollar can never experience a Weimar-style hyperinflation. But this is a complete red-herring. The foreign debt was not the cause of the confidence collapse. It was only the fuel that forced the government printing... the second stage boost in hyperinflation. In our case we have a different kind of fuel, the most over-sized federal government the world has ever known!
And as the dollar confidence fails, those famous "$100T unfunded obligations" will have the exact same effect as Weimar's "foreign denominated debt." Think it through! As general price levels go exponential so do government obligations!
Let’s read FOA’s famous quote again:
"My friend, debt is the very essence of fiat. As debt defaults, fiat is destroyed. This is where all these deflationists get their direction. Not seeing that hyperinflation is the process of saving debt at all costs, even buying it outright for cash. Deflation is impossible in today's dollar terms because policy will allow the printing of cash, if necessary, to cover every last bit of debt and dumping it on your front lawn! (smile) Worthless dollars, of course, but no deflation in dollar terms! (bigger smile)"
And here's one more for the road:
"Yes, even my untrained eye can see that we are approaching the end of a currency life cycle. When all of the debt can no longer be rolled over, the world does not end. It moves on, into another fresh system! This current contraction will not create a deflation as it did in the past. It will involve a rollover that will balance the losses for some with the gains for others. Will your wealth balance in this event? FOA"
Sincerely,
FOFOA
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