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Can Hyperinflation Happen Overnight?

Posted by Larry Doyle on June 11, 2010 12:50 PM |

Are the financial wizards in Washington and around the world concocting potions and building financial models which may create a greater crisis than that we are currently experiencing? What type of crisis might that be? Our friends in Germany know all to well about the perils of hyperinflation. Could we be facing the same prospects? While our central bankers are touting the current benefits of limited inflation, to be fair the bankers and the economy are battling the undercurrents of disinflation and deflation.

Could those currents change on a dime and create a ‘funnel’ in which our economy is engulfed by hyperinflation? Let’s navigate this topic and review a commentary put forth by Daryl Montgomery, a guest on No Quarter Radio’s Sense on Cents with Larry Doyle from March 7th. Daryl is a fellow contributing author at Seeking Alpha and writes on this topic today,

While everyone acknowledges that governments are printing and printing excess amounts of new money, more market observers are currently worried about deflation rather than inflation. There is a smaller group concerned about hyperinflation, but the theoretical underpinnings have been missing up to now that would justify how this could be possible. There is an explanation though and this indicates that hyperinflation can not only take place, but that it can happen suddenly.

There have been a number of impediments in how economists look at hyperinflation that have prevented original thought (and sometimes any thought at all) in this area. Here are the necessary ideas:

1. Inflation is a currency losing its value (an idea most mainstream economist can’t seem to grasp).

2. Severe deflation is a precursor to hyperinflation. They are not inconsistent events as is generally thought, but deflation sets the stage for hyperinflation.

3. Disinflation/deflation and inflation need not by symmetrical. For instance, if there is 30 years of disinflation, this doesn’t have to be balanced by 30 years of inflation. The same amount of inflation could take place in only months or even weeks, let alone 30 years.

4. Inflation doesn’t have to be a continuous phenomenon. The chart can have gaps in it with prices going up significantly overnight. Furthermore this can start from a low point where almost no inflation exists.

The origins of hyperinflation are with excess ‘money’ printing by a government. It is not possible to produce an ever-larger amount of currency and have each unit of that currency maintain its value. If it were, real money could be created out of thin air and everyone in the world could become infinitely rich overnight. This would also violate the basic laws of arithmetic. So excess money printing always devalues a currency and because of this less and less can bought with each unit of that currency.

This becomes a potentially dangerous problem when severe deflation takes place because of a shock to the financial system (the Credit Crisis for instance). To make up for the loss in value of assets (deflation), the government prints a huge amount of money. The printing causes devaluation of the currency and requires more printing to try to make up for the additional loss of value. A self-feeding money printing cycle then develops.

Even though huge money creation has occurred because of the Credit Crisis, we still haven’t seen significant inflation yet. Indeed, the American government claims the U.S. inflation rate has fallen close to zero. How is this possible? The answer can be found in the banking system. The feds have pumped huge amounts of money into it (U.S. bank reserves have increased approximately 100 times or 10,000% since the Credit Crisis began) and banks have received this money at close to a zero percent interest rate. Yet, if you look at commercial and consumer bank lending, you will see that they have been declining. So where did all this money go? It was used to buy treasuries and this is what is allowing the federal government to fund its massive deficits. For all intents and purposes, this is a massive Ponzi scheme being run by the U.S. government.

Ponzi schemes, though, don’t follow the same rules as normal businesses or economic statistics. They build to a crescendo over time and then suddenly collapse to zero instantly. The analogy for inflation will be the opposite, however. Inflation will go to zero and then suddenly jump up to some very high level. In theory, zero interest rates should produce infinite inflation (hyperinflation), but nothing mandates that this has to be a gradual, long-term process. If you think about it, the Credit Crisis seems to have come out of nowhere. It didn’t of course; there was a slow, long-term build up behind the scenes that just exploded suddenly. Inflation is likely to follow that same path of development. Global governments eventually got control of the Credit Crisis collapse by throwing trillions of dollars at the problem. That solution, however, won’t work for dealing with inflation.

Can this scenario take place here in the United States? Might the scenario happen elsewhere in the world first before landing in America? Might the wizards literally lose control of the potions and the grand experiments?

I will discuss this topic and much more this Sunday evening (8-9pm) as Daryl Montgomery returns to No Quarter Radio’s Sense on Cents with Larry Doyle.

LD

  • Matt

    Excellent, excellent question Larry. Probably the most important question and topic there is for investors right now. Mr. Montgomery is absolutely right that Ponzi schemes collapse to zero overnight – we saw this with Bernie Madoff. Madoff investors had millions of dollars for many years, and then literally woke up one morning and all of the sudden, they had zero. Poof! Just like that. Overnight. I do agree that the same thing can happen with our global financial system. Once there is a failed US Treasury Bond Auction, I think something similar could occur. We are still very much sailing through uncharted waters in many respects today, so the specific consequences and ramifications of a failed US Treasury Bond auction are pretty much impossible to predict. This is an crucially important topic Larry and I appreciate you addressing it and continuing to monitor it.

    Matt

  • Bill

    The hyperinflation in Germany played out over a fairly short time frame–between two and three years. At the end you saw some breath taking revaluations. The value of all German mortgages dropped in US $ terms from $10 billion US to one penny. A shopper would walk into a store, and there was a sign with a number–2, 3, 4 whatever. You multiplied the price of items by that number, which could change while you were waiting in line to pay. The same ones who say it can’t happen here are probably the same ones who thought housing prices would never drop nationally. Those of us who lived through the 1970’s know better. Currently the velocity of money is below trend, and it is one of the components of the money supply. During hyperinflation, the velocity of money skyrockets. The cause of the German hyperinflation was the central bank buying the debt of the Weimar Republic, just as is occurring in the US.

  • Mike

    Well I certainly hope the banks have all that extra money behind some very secure safes.

  • Patriot

    Larry…. you’ve hit upon an important topic.
    After all, looking back;
    the establishment of the Fed, going off the Gold standard,
    rampant debt and this current ‘spin all events’ by recent administrations are harbingers of a ponzi reaching its zenith.

    Yes, ponzi schemes collapse when the word gets out.

    Are we close to the realization that mostly all our institutions, our icons, our ‘truths’ are in reality…false?

    For me…long since yes.
    For the bulk of others… perhaps now we are reaching a critical mass.

  • Barry

    The whole US financial system is a giant ponzi scheme..and the economy is a house of cards! We are at the tipping point and the whole thing is going to come crashing down. The architects of this ponzi scheme need to be taken down.






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