Download How Likely is Hyperinflation in the US? Part One

How Likely is Hyperinflation in the U.S? Part
One
June 23, 2015
by Seaborn Hall
Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily
represent those of Advisor Perspectives.
Since the great financial crisis (GFC) of 2008-2009, perhaps the most talked about scenario for the
next crisis to hit the U.S. has been hyperinflation due to high levels of Treasury debt and Federal
Reserve Bank liabilities. Fortunately, the logic that produces this chain of events is specious.
Still, experts and pundits propose various scenarios for whether, why, how and when hyperinflation will
hit the U.S. At least one writer has predicted hyperinflation almost every year since 2010. Even U.S.
politicians have asserted that Fed money printing will result in hyperinflation, illustrating how easily it is
misunderstood. These warnings may sound to the public like Chicken Little's cry that the sky is falling.
Other experts are more cautious, and some even dismissive. An article in The Economist recently
asserted that extrapolating hyperinflation from the ugly scene in Washington is to misunderstand how
America works.
Because there are so many conflicting and different views among analysts relating to hyperinflation, it
is difficult for the average American investing for retirement – or just self-preservation – to know what
to believe and how to act. What is hyperinflation, why does it happen, how is it different from high
inflation, how might it happen in the U.S. and if it does, how do we prepare?
This article sifts through the best resources available, including Bank for International Settlements
(BIS), International Monetary Fund (IMF), Cato Institute and Fed papers to provide answers.
The process and effects of hyperinflation
The effects of hyperinflation have been frightening whenever they have occurred. In Weimar Germany
from 1922-1923, bread lines were common, homes were lost, paper currency was burned for heat and
many died from starvation. In Brazil during the late 1980s to early 1990s, the middle class virtually
disappeared when wage advantages and savings were lost to consistently rising prices. And, in
Zimbabwe, just a few years ago, food shortages forced those once well-fed to make meals out of
caterpillars.
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Regardless of how quickly it comes, how it begins and how high it goes, hyperinflation results in crisis
for a nation's inhabitants. At the beginning of a hyperinflation, prices double about every two months,
but this tends to increase rapidly. The Weimar inflation saw a top inflation rate of 29,500% per month.
The Brazil hyperinflation's top rate was 82.4% per month. The highest hyperinflation rate occurred in
post-WWII Hungary and was 4.19 × 10-to-the-16th power percent. This is equal to a daily rate of
208% with prices doubling every 15 hours. Most of us have no ability to comprehend inflation of this
nature and its effects.
As one observer noted, inflation is an immoral tax that leads to immoral values. Hyperinflation is worse.
The generic process and effect of historical hyperinflations from Revolutionary France to Weimar
Germany to the more recent Zimbabwe is something like this:
First, prices may increase imperceptibly; then, due to a supply shock, capital event, war or political
mismanagement of a regime trying to stay in power they increase quickly. The national stock markets
rise higher. Wages may spiral upward to match price increases. Hoarding begins.
Consuming is no longer entertainment – it is war. Goods at markets begin to sell out almost as quickly
as products hit shelves. This is especially true of essential staples and food. Approximately a third of
essential goods become unavailable. In Weimar Germany, renters gained over landlords when prices
rose faster than government rent controls. Those on fixed incomes with most of their assets in local or
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government bonds begin to struggle due to falling values followed by bond default. Those who
borrowed before inflation increases have an advantage over lenders – as long as they can make the
payments, and mortgages don't have inflation clauses. Many who can't make payments lose their
homes, which are either repossessed by the banks or bought on the cheap by the super-wealthy or the
prescient. True class separation occurs, with a dwindling middle class giving way to a lower
impoverished class, creating social tension.
In the investment arena, most domestic stock holdings decrease. No one holds cash because it
devalues so quickly. Every essential or investable product for sale disappears fast. A black market
develops, usually based on a stable foreign currency. Flight to foreign currencies and international
securities has already begun. But since the government institutes fines for foreign currency purchases,
premiums are 300% or more. Banks are either closed for a time, or a strict limit is put on withdrawals.
In extreme cases gold stored in safety deposit boxes may be confiscated.
Bartering as a substitute for cash becomes commonplace. Goods like flour, sugar, wine, precious
metals and jewelry, artwork and musical instruments are common tradable items. Pianos were a
valuable trading item in Weimar Germany for example. Some who are savvy enough to arbitrage, using
border nations, make a little profit. Only those who have thought ahead do more than survive. They use
gold, silver or foreign currency stores to buy up assets and real estate at cheap prices. But, those with
assets, land or agriculture become targets of roving criminal gangs, looking for food to survive or
engaged in looting for profit. Lawlessness takes root and grows, and only the armed can defend
themselves.
In the last stages of hyperinflation the economy collapses. An increasingly authoritarian government
pegs its local currency to a stable foreign currency, and installs a new and respected head of the
central bank, who pledges to act independently of the government. There may be a "new," or several
new currencies, depending on the sincerity of the government and how well the populace receives
them. Zimbabwe implemented several currencies before change was widely received and a new
currency linked to the dollar firmly took hold. Each time this occurs, it takes many more old units of
currency to buy the new ones, stripping wealth from the populace. Only those with foreign currency
and gold, who refrain from speculation and have a diversified portfolio and tradable items, weather the
storm.
Much like living through a depression, the afflicted bear the scars of hyperinflation for a lifetime.
Afterwards, it is often difficult for those affected to refrain from taking refuge in authoritarian,
charismatic leaders. The rise of Hitler following the hyperinflation of Weimar Germany in the early
1920s is partially attributed to the deep psychological wound the nation suffered during that period and
the manner in which wealth was taken from the lower and middle classes.
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Definition, types and causes of hyperinflation
There have been at least 56 hyperinflations since the late 18th century, and all of them have included
many of the effects described above. Following Phillip Cagan, hyperinflation is defined as beginning in
a month in which price rises are over 50%%, and ending the month before price rises drop below 50%
and stay there for at least one year. According to Steve H. Hanke and Nicholas Krus, academics at
John Hopkins University, hyperinflation has never appeared where a currency is linked to a commodity.
A few aspects of hyperinflation need to be highlighted. As James Montier of GMO pointed out, it is an
incessantly repeated myth, or "false memory," that central bank money printing alone causes
hyperinflation. The longest hyperinflation, in Nicaragua in the late 1980s, lasted almost five years. The
average length of a hyperinflation is 12 to 18 months, while different types of high inflation typically last
three to four years. The point at which high inflation is more likely to devolve into higher inflation or
hyperinflation is at above 200% per year.
Historically there is evidence of at least two types of hyperinflation. The first is classical-fast-acting, or
post-World War (WW) type hyperinflation catalyzed by war or other sudden supply disruptions;
Zimbabwe and Iran are modern examples. The second type is South American hyperinflation typified
by nations like Brazil and Argentina and characterized by long periods of high inflation that morph into
hyperinflation over time usually due to a crisis that hits an already unstable economy.
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Contrary to Reinhart and Savastano, modern hyperinflation is not limited to this second type. But they
accurately note that hyperinflation may be expected when the currency exchange premium – the
premium the most used foreign currency commands over the native currency – rises above 50%. This
typically occurs during a period of high inflation and up to three years before hyperinflation appears.
This period may or may not include a currency crisis, which is distinct from high inflation or
hyperinflation and can be an initial phase of either.
The causes of hyperinflation differ according to type. In classical-fast-acting the primary causes are
supply disruptions, including war, drought, sanctions, high foreign debt, war reparations and
transmission mechanisms like distributive conflict or over-regulation. Distributive conflict occurs when
supply lines are shut down due to war, sanctions or other disruptions. Over-regulation, like indexing to
link prices and wages or price controls, may result in lowering production and product availability longer
term. In the chronic high inflation type of hyperinflation, the primary causes appear to be high foreign
debt, negative deficits and eventual monetization as a means of financing high deficits.
But there is an intersection of causes between the types: mismanagement, over-regulation, foreign
debt, deficits and monetization. Bernholz's classic Monetary Regimes and Inflation clarified the
specific deficit criteria as a deficit-expenditure ratio over 20%, though Fischer, Sahay, and Vegh may
limit this to countries already experiencing high inflation.
It is also possible, according to Dylan Grice and hedge fund manager Kyle Bass, that Japan will be the
cautionary tale for the U.S. relative to hyperinflation. According to Grice, debt monetization, which
many assert is occurring in Japan presently, is a necessary but not sufficient condition for creating
hyperinflation; persistent monetization is a sufficient condition. Grice also mentions rising mandatory
plus interest expenditures as an emerging symptom of future high inflation in Japan.
Finally, inferring from Hanke and others, hyperinflation ultimately occurs when government policies
force monetization to pay debts. So, to all of the above causes of hyperinflation add this primary cause:
political mismanagement, especially the intentional acts of a socialist administration or dictator who
attempts to control or maintain power.
Causal symptoms of hyperinflation: measuring its emergence
To understand what the appearance of hyperinflation might look like in the U.S., let’s examine the
causes outlined above in the context of how they have appeared or may be appearing in other nations.
Then these causal symptoms are measured relative to the U.S. But note that Cagan admitted that his
definition of hyperinflation was arbitrary, so it may need revisiting. As an aside, hyperinflation may be
difficult to distinguish from its typical precursor, extreme high inflation, usually considered to be in
excess of 100% per year.
Perhaps most instructive in this regard are the movements of four nations into high inflation, just short
of what is considered hyperinflation. These nations are Iran, Venezuela, Argentina and Russia. At an
estimated 492% and about 20% per year inflation respectively, the middle nations are examples of high
inflation that could become South American hyperinflation. The first and the last nations may become
examples of fast-acting modern era hyperinflation. In either case, inflation needs to rise above 50% per
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month.
Venezuela and Argentina both experienced high inflation – Argentina, hyperinflation – in the 1980s,
and both have similar problems today: high foreign debts, defaults, supply disruptions and transmission
mechanisms, exacerbated by political mismanagement that has driven annual inflation up. According to
Michael K. Salemi, economics professor at University of North Carolina at Chapel Hill, high debt, rising
interest rates and monetization caused the Latin American high inflation of the 1980's.
By some measures, Iran may have begun experiencing hyperinflation by October of 2012, when at
least one source suggested inflation was approaching 70% per month. Western-imposed sanctions
have taken their toll on Iran and now Russia. The currency exchange rate premium there broached
50% with the U.S. dollar in 2014. And according to the same opinion in the Financial Times (FT),
Russia's problems are complicated by more than just sanctions, and include central bank errors,
waning investment and, like Venezuela, an economy too dependent on oil exports. Syria is a fifth nation
that has begun to experience problems due to its current civil war; the annual inflation rate there is
higher than 75%.
Brazil in 1989-1990 was a case of chronic very high inflation that exploded into hyperinflation.
According to Pereira and Nakano, increasing foreign debt in the 1970s led to sustained high inflation.
An external shock due to interest rates and oil prices hit the economy in 1979, and then suspension of
foreign sources of finance in 1982 led to accelerating monetization to finance the deficit. According to
Garcia, indexing and domestic currency conversions and substitution were unique factors that
sustained high inflation. Interest bearing accounts linked to inflation were converted to demand deposit
accounts on a bi-monthly basis and allowed domestic holders to avoid foreign currency substitution.
Indexing "stepped-up" inflation to new and higher levels on a consistent basis. But, eventually investors
fled government securities for foreign investment, and a crisis within the weakened macroeconomy
resulted in hyperinflation.
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Zimbabwe's experience illuminates many aspects of fast-acting hyperinflation. From its inception in
1980, Zimbabwe, the first true hyperinflation of the 21st century and the second highest ever, was a
nation about the size of California considered to be the breadbasket of Africa. In 1997 rumors of civil
repression caused the stock market to crash, losing 88% in value in a year. High inflation soared then
was curtailed.
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Mugabe, the socialist prime minister, began a violent campaign against his political opponents that has
now lasted more than a decade. David Coltart, a Zimbabwe Parliament member, writing for The Cato
Institute in 2008, documents how in 2002 white land owners were killed and land seized was taken
over by government ministers, party operatives, army commanders and judges, and then mismanaged.
Agricultural production waned, followed by a collapse of the banking, manufacturing and industrial
sectors from 2002 to 2007. During this period, the constitution, already weak, was amended to favor
the executive branch even more and eliminate white property and business ownership. Military
intimidated or shut down media outlets for reporting the truth. Food shortages and distribution began to
be used as a weapon for political capital. Lack of ability to pay for critical imports led to un-budgeted
expenditures then to monetization.
The Zimbabwe central bank offered no resistance to direct funding of the government debt.
Transmission mechanisms like over-regulation and price controls made conditions worse. Then around
2005, a drought exacerbated the existing supply shock that began a cycle of debt to the IMF, higher
inflation, more monetization, further mismanagement and emigration that by 2007 plunged the nation
into an inflationary collapse.
America's multi-layered rule of law and political and social institutions make it presently different than
Zimbabwe. What can be ascertained from the above cases is that hyperinflation does not come out of
nowhere, and it almost always can be traced back to causes and causal symptoms that warn of its
appearance.
In fast-acting hyperinflation, supply disruptions or political mismanagement are typically a primary
catalyst. According to Craig Richardson in The Cato Journal, the loss of individual property rights was
the primary instigator of the Zimbabwe collapse and directly led to the downward spiral of the economy.
In the South American type chronic high inflation precedes it and a crisis within that context ignites the
spark that explodes into hyperinflation. In most cases of both types, monetization and high currency
exchange premiums (right) are prescient symptoms that hyperinflation is immediately on the horizon.
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To sum up, hyperinflation does not magically appear in a global reserve nation governed by the rule of
law without warning, crisis and a chaos of change. The Economist was partially right recently when it
said, "Hyperinflation...is a symptom of total social and political collapse. And while it would be unwise to
say that it could never happen in America, it is simply mistaken to say that it could happen because
Congress was too foolish to balance its budget."
But hyperinflation is not always due to social and political collapse. It can emerge from economic
outcomes as it did in South America in the late 1980's-90's. Poor macroeconomic performance can
lead to high inflation, and high debt can lead to high interest rates, resulting in government's inability to
pay what they owe. Then a crisis in the midst of high inflation can force monetization and lead to
hyperinflation. But, this has never happened in a global reserve nation without apparent political and
social disintegration. And, as it was pointed out, South American Socialist governments exacerbated
economic causes with political mismanagement.
That said, how does the U.S. hold up in a survey of these causal symptoms? And, if the symptoms are
not clearly defined, what are the emerging dangers? These issues, as well as when and how
hyperinflation might happen in the U.S. and how to prepare for the eventuality will be addressed in
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Hyperinflation in the U.S.A., part two.
Seaborn Hall, AIF, has been involved in some facet of the investment arena for over 30 years. He
has a degree in management from Georgia Tech, two Masters degrees in theology and has studied
at the doctoral level. Until recently he was a regional director at a top national RIA, with headquarters
in California; he now focuses on managing a family investment company.
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