December 15th, 2008
I keep reading about the dollar being a "new multi-year bull market" and that the US is headed for "Japan style deflation". Frankly, it is a little tiring. The people making these arguments should know better.
Deflation vs Hyperinflation
Yes, there is debt deflation, and the overall money supply is shrinking as a result. However, those calling for "multi-year bull market" for the US dollar are insane. These individuals need to review basic monetary theory. The money supply is only one of three factors that determine whether prices rise or fall. The other two are the changes in the velocity of money and the real output of the economy. The danger of hyperinflation lies in a dramatic increase in the velocity of money due to a loss of confidence, not in changes in the money supply.
Confidence and the Velocity of Money
When confidence in an issuing authority crumbles, money starts flowing through the economy at a feverish pace. For example, in normal, noninflationary times the money supply might be equivalent to three months of output, but in a period of hyperinflation it might drop to two weeks worth of output. Since increases in the velocity of money have the same impact on prices as increases in the money supply, a 1000% increase in the velocity of money (typical in any period of hyperinflation) is equivalent to a 1000% increase in the money supply. Due to its effects on the velocity of money, the ebb and flow of confidence have a much greater impact on the short-term trend of prices then changes in the money supply.
Deflation Can Create Hyperinflation
It is no accident that many of the worst periods of hyperinflation are preceded by deflation. In fiat currencies with high levels of government debt, severe cases of deflation cause a loss of confidence in the nation's currency by shrinking the economy and making the government's debt appear increasingly unsustainable. The loss of confidence then causes the flow of money to speed up as individuals become desperate to exchange cash for real goods as fast as possible, producing hyperinflation.
As an example of deflation leading to hyperinflation, consider the case of the Weimar Republic. In 1920, Germany experienced a deflationary collapse, with the average citizen finding it harder and harder to get enough money for necessities. Banks, short of money, could not honor checks, and businesses were strapped for cash to buy materials and meet payroll. Fearing a collapse that would throw millions of workers out on the street, the German government desperately printed money in an attempt to re-inflate the economy. During this period, despite the government's money printing, the mark actually gained in value against foreign currencies, so that prices of imported goods fell by some 50%.
Eventually, as a result of the money supply's rapid expansion, the nation's massive foreign debt, and the shrinking economy, German citizens lost all confidence in their currency, and the Weimar Republic experience one of the worst cases of hyperinflation in modern economic history. Billions of hoarded marks came out of hiding and entered the marketplace. The chart below tells the rest of the story.
How Deflation Creates Hyperinflation
- Deflation slows the speed of money to crawl due to fears about the deteriorating economy. The public hoards cash, or, in the case of the US, short term treasuries.
- The slowing speed of money and debt destruction force the government to create huge quantities of cash to prevent prices and the economy from collapsing. However, because the public is hoarding cash (or short term treasuries), most of the money doesn't reach the real economy, which leads the central bank to print even more money. In essence, cash hoarding acts as a dam, preventing the enormous quantities of printed money from affecting prices.
- Deflation weakens economy until it leads to a loss of confidence. With doubts about the government's solvency growing, the velocity of money quickly picks up speed, and a flood of hoarded cash comes out of hiding, entering the marketplace all at once and creating hyperinflation.
US Stands on the Verge of Hyperinflation
Gold Backwardation signals that the next phase of the economic crisis, a rapid acceleration in the velocity of money, is about to begin. Right now, the flow of money through the economy is basically frozen: everyone is panicking into treasuries due to deflation fears. Negative yields on the 3 month treasuries are a sign of this.
Despite the glacial rate money is moving through the economy, the dollar has started to fall again, and gold has begun to rally. As this continues, investors will begin to questions the safety of treasuries, and sell them off. The money coming out of treasuries will add fuel to gold's rise and the dollar's fall. Once the dollar hits new lows and gold breaks convincingly over $1000, Investors expecting deflation will begin to panic, and a flood of money will come out of treasuries. It is then that hyperinflation will begin in earnest.
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© 2008 Eric deCarbonnel
ABOUT THE AUTHOR
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Eric deCarbonnel is the editor of MarketSkeptics, a website devoted to providing insights by taking a hard look at the economy and financial system while ignoring the mindless optimism that oozes out of Wall Street promoters in the financial media. By understanding the big picture and the fundamentals driving the economy, MarketSkeptics aims to predict broad trends in the market and highlight attractive investment opportunities. |
Disclaimer:
The opinions expressed above are not intended to be taken as investment advice. It is to be taken as opinion only and I encourage you to complete your own due diligence when making an investment decision.
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Posted in Current Events, Monetary Commentary, Guest Commentary, Hyperinflation, Michael Pento
Comments (7)
Posted by TmjB on March 21st, 2009:
The nightmare of Weimar 2 is coming, probably faster than we can imagine. G20 meeting will be a determining factor...
http://tinyurl.com/clck4y
mB |
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Posted by Christopher Wilson on February 18th, 2009:
Well you know the old expression: there are as many economic theories as there are economists in the room and this is certainly one theory you have produced.
But I am not sure it is right. I think its predicates are wrong.
First unlike Germany following the 1919 Versailles Treaty the US has not only got control of its own fiscal destiny but, unlike Germany which owed billions in reparations to third parties under the treaty and had lost the means of production to earn revenue to pay the debt or indeed the political will to pay the debt, the US can and will pay up.
I do not accept the author's point that hyperinflation follows deflation like Spring does Winter or if the theory has any validity I do not accept that the inflation, if it is a reaction to deflation, is necessarily "hyper".
Collaterally I do not accept that gold has anything like the magical allure today that it did in the 1920's or ever the 1970's. Today we have got far too good at sourcing and producing gold to make it a finite commodity which it needs to be in order to be an arbiter of financial value. At best it is a scare resource, but not as scarce as many other resources including platinum.
This a "shake out" period. The strong are going to buy well and low and rise like yeast in a good pudding to the top. The weak are going to sell and disappear. As indeed they are. This is an artificially created change in our world, it is not like Europe in the middle ages after the Black Death or at the beginning of the recent mini ice age which finished about 1900. It is more like the South Sea Bubble except more bubbly. It is not even like the agrarian depression of the 1930s where more than 50 per cent of the population was farm related and which saw farming land disappear. These were all fundamental geophysical changes resulting in economic catastrophe. We don't have that; pace global warming/cooling bugs.
Nothing is different in our world except a lot of banks have got caught with their knickers around their knees and , in the fine traditions of bankster's, are making their customers (either as borrowers or taxpayers) rather than their stock holders pay for their calumny.
Perhaps one should ask our brokers to make a list of 20 companies which are best set to thrive on economic down turn and then invest in four of them in at least three different sectors of the economy and at least two different currency jurisdictions? Their basic characteristics should be:
a low p/e ratio
little or no unsecured third party debt
production in an economic sector which is thriving on thrift or thrives on misery (drinks industry)
a strong management team
a board of directors who are specialists not parachuted in to make it look good
and a published five year plan it sticks too.
It is going to be possible to make more money faster in the next five years than ever in the history of mankind. And it is going to be made by fewer people than ever: be one of those people. |
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Posted by Fred J on January 4th, 2009:
Kimo: Where's the money going to go? Into tangible commodities that hold their value...gold bullion comes to mind.
Inflation is here and has been for quite some time. Check out the article "Sinking Currencies" by Mike Hewitt - it shows how the purchasing power of the US dollar has declined since 1774.
http://dollardaze.org/blog/?post_id=00402&cat_id=20 |
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Posted by Kimo on January 1st, 2009:
"investors will begin to questions the safety of treasuries, and sell them off."
exactly where is this money supposed to go? Equities? Bonds? Toys from China?
Hyperinflation. In the face of all these layoffs and overseas downward wage pressure, who wants to bet on a upward wage spiral here in the US? And without escalating wages, the old adage, "nothing cures high prices like high prices" remains in effect. Eric, someday there will be inflation, but it is many years away! It is you, my friend, that needs to get real.
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Posted by Jim on December 25th, 2008:
So what do we do to stay alive? Will everything hyperinflate or just select things, ie. food, oil, gold? |
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Posted by Jt on December 24th, 2008:
Was there one event that set off the exponential rise in the Weimar experience? What do you think may be the "event" here? I know it'd just be a guess, a hunch, a gut feeling. But what will be the sign to you that gold's taking off and/or the dollar's freefalling? Do you think it will be the dollar freefalling?...it already had a drop of >10%, and looks to be setting up for its next fall.
You know the PPT, the Currency Stabilization Fund, the anti-gold/silver cartel (basically JPMorgain4Elites), ie, the total PTB bankster and friends' manipulations, won't just go away easily. Do you think they'll just stop manipulating at some moment and start buying all the gold they can get their hands on? What are you seeing, looking for, expecting? TIA...jt |
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Posted by NealPhx on December 24th, 2008:
Wow! Absolutely brilliant and right on! The best article I have read to date that explains the current strange paradigm with the dollar and the teasuries and (of course)Gold! |
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